Newswires
$ 44,336.9$ 2,535.2 $ 885.9 $ 45,986.2 $ 44,491.5 $ 3,792.6 $ 825.7 $ 47,458.4 The following tables present the carrying amount and the gross unrealized losses, including other-than-temporary impairment losses reported in OCI, on investment grade fixed maturities available-for-sale by aging category as of the periods indicated. June 30, 2013 Public Private Total Gross Gross Gross Carrying unrealized Carrying unrealized Carrying unrealized amount losses amount losses amount losses (in millions) Three months or less $ 5,396.3 $ 181.9 $ 2,196.3 $ 61.4 $ 7,592.6 $ 243.3 Greater than three to six months 191.9 11.1 85.2 3.8 277.1 14.9 Greater than six to nine months 134.4 10.9 22.0 2.5 156.4 13.4 Greater than nine to twelve months 46.3 4.4 - - 46.3 4.4 Greater than twelve to twenty-four months 65.2 3.7 54.3 0.8 119.5 4.5 Greater than twenty-four to thirty-six months 72.5 8.6 47.5 8.0 120.0 16.6 Greater than thirty-six months 491.9 103.7 471.8 91.0 963.7 194.7 Total fixed maturities, available-for-sale $ 6,398.5 $ 324.3 $ 2,877.1 $ 167.5 $ 9,275.6 $ 491.8 December 31, 2012 Public Private Total Gross Gross Gross Carrying unrealized Carrying unrealized Carrying unrealized amount losses amount losses amount losses (in millions) Three months or less $ 646.6 $ 3.7 $ 227.1 $ 1.5 $ 873.7 $ 5.2 Greater than three to six months 148.4 2.1 31.8 0.4 180.2 2.5 Greater than six to nine months 21.3 0.3 50.6 0.6 71.9 0.9 Greater than nine to twelve months 34.6 1.0 7.1 0.1 41.7 1.1 Greater than twelve to twenty-four months 205.8 17.7 167.6 10.0 373.4 27.7 Greater than twenty-four to thirty-six months 72.2 8.8 41.9 0.9 114.1 9.7 Greater than thirty-six months 811.6 165.3 706.9 129.2 1,518.5 294.5 Total fixed maturities, available-for-sale $ 1,940.5 $ 198.9 $ 1,233.0 $ 142.7 $ 3,173.5 $ 341.6 120
PRINCIPAL FINANCIAL GROUP INC – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
| Edgar Online, Inc. |
The following analysis discusses our financial condition as ofJune 30, 2013 , compared withDecember 31, 2012 , and our consolidated results of operations for the three and six months endedJune 30, 2013 and 2012, prepared in conformity with U.S. GAAP. The discussion and analysis includes, where appropriate, factors that may affect our future financial performance. The discussion should be read in conjunction with our Form 10-K, for the year endedDecember 31, 2012 , filed with theSEC and the unaudited consolidated financial statements and the related notes to the financial statements and the other financial information included elsewhere in this Form 10-Q. Forward-Looking Information Our narrative analysis below contains forward-looking statements intended to enhance the reader's ability to assess our future financial performance. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and contain words and phrases such as "anticipate," "believe," "plan," "estimate," "expect," "intend" and similar expressions. Forward-looking statements are made based upon management's current expectations and beliefs concerning future developments and their potential effects on us. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those included in the forward-looking statements as a result of risks and uncertainties including, but not limited to, the following: (1) adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, as well as our access to capital and cost of capital; (2) continued difficult conditions in the global capital markets and the economy generally may materially and adversely affect our business and results of operations; (3) continued volatility or declines in the equity markets could reduce our assets under management ("AUM") and may result in investors withdrawing from the markets or decreasing their rates of investment, all of which could reduce our revenues and net income; (4) changes in interest rates or credit spreads may adversely affect our results of operations, financial condition and liquidity, and our net income can vary from period-to-period; (5) our investment portfolio is subject to several risks that may diminish the value of our invested assets and the investment returns credited to customers, which could reduce our sales, revenues, AUM and net income; (6) our valuation of fixed maturities, equity securities and derivatives may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition; (7) the determination of the amount of allowances and impairments taken on our investments requires estimations and assumptions which are subject to differing interpretations and could materially impact our results of operations or financial position; (8) any impairments of or valuation allowances against our deferred tax assets could adversely affect our results of operations and financial condition; (9) gross unrealized losses may be realized or result in future impairments, resulting in a reduction in our net income; (10) competition from companies that may have greater financial resources, broader arrays of products, higher ratings and stronger financial performance may impair our ability to retain existing customers, attract new customers and maintain our profitability; (11) we may not be able to protect our intellectual property and may be subject to infringement claims; (12) a downgrade in our financial strength or credit ratings may increase policy surrenders and withdrawals, reduce new sales and terminate relationships with distributors, impact existing liabilities and increase our cost of capital, any of which could adversely affect our profitability and financial condition; (13) our efforts to reduce the impact of interest rate changes on our profitability and retained earnings may not be effective; (14) guarantees within certain of our products that protect policyholders may decrease our earnings or increase the volatility of our results of operations or financial position under U.S. GAAP if our hedging or risk management strategies prove ineffective or insufficient; (15) if we are unable to attract and retain qualified employees and sales representatives and develop new distribution sources, our results of operations, financial condition and sales of our products may be adversely impacted; (16) our international businesses face political, legal, operational and other risks that could reduce our profitability in those businesses; (17) we may face losses if our actual experience differs significantly from our pricing and reserving assumptions; (18) our ability to pay stockholder dividends and meet our obligations may be constrained by the limitations on dividendsIowa insurance laws impose on Principal Life; (19) the pattern of amortizing our DAC and other actuarial balances on our universal life-type insurance contracts, participating life insurance policies and certain investment contracts may change, impacting both the level of the DAC and other actuarial balances and the timing of our net income; (20) we may need to fund deficiencies in our Closed Block assets; (21) a pandemic, terrorist attack or other catastrophic event could adversely affect our net income; (22) our reinsurers could default on their obligations or increase their rates, which could adversely impact our net income and financial condition; (23) we face risk arising from acquisition of businesses; (24) we face risks arising from the acquisition of Cuprum; (25) changes in laws, regulations or accounting standards may reduce our profitability; (26) we may be unable to mitigate the impact of Regulation XXX and Actuarial Guideline 38, potentially resulting in a negative impact to our capital position and/or a reduction in sales of term and universal life insurance products; (27) a computer system failure or security breach could disrupt our business, damage our reputation and adversely impact our profitability; (28) loss of key vendor relationships or failure of a vendor to protect information of our customers or employees could adversely affect our business or result in losses; (29) results of litigation and regulatory investigations may affect our financial strength or reduce our profitability; (30) from time to time we may become subject to tax audits, tax litigation or similar proceedings, and as a result we may owe additional taxes, interest and penalties in amounts that may be material; (31) fluctuations in foreign currency exchange rates could reduce our profitability; (32) applicable laws and our certificate of incorporation and by-laws may 89 --------------------------------------------------------------------------------
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discourage takeovers and business combinations that some stockholders might consider in their best interests and (33) our financial results may be adversely impacted by global climate changes.
Overview
We provide financial products and services through the following reportable segments:
† Retirement and Investor Services, which consists of our asset accumulation operations that provide retirement savings and related investment products and services. We provide a comprehensive portfolio of asset accumulation products and services to businesses and individuals in the U.S., with a concentration on small and medium-sized businesses. We offer to businesses products and services for defined contribution pension plans, including 401(k) and 403(b) plans, defined benefit pension plans, nonqualified executive benefit plans and employee stock ownership plan consulting services. We also offer annuities, mutual funds and bank products and services to the employees of our business customers and other individuals. †Principal Global Investors , which consists of our asset management operations, manages assets for sophisticated investors around the world, using a multi-boutique strategy that enables the segment to provide an expanded range of diverse investment capabilities including equity, fixed income and real estate investments.Principal Global Investors also has experience in currency management, asset allocation, stable value management and other structured investment strategies.
†
†U.S. Insurance Solutions , which provides individual life insurance as well as specialty benefits in the U.S. Our individual life insurance products include universal and variable universal life insurance and traditional life insurance. Our specialty benefit products include group dental and vision insurance, individual and group disability insurance, group life insurance, wellness services and non-medical fee-for-service claims administration. † Corporate, which manages the assets representing capital that has not been allocated to any other segment. Financial results of the Corporate segment primarily reflect our financing activities (including interest expense and preferred stock dividends), income on capital not allocated to other segments, inter-segment eliminations, income tax risks and certain income, expenses and other after-tax adjustments not allocated to the segments based on the nature of such items.
Transactions Affecting Comparability of Results of Operations
Acquisitions
We entered into acquisition agreements for the following businesses during 2013 and 2012.
Liongate Capital Management . OnMay 1, 2013 , we finalized the purchase of a 55% interest inLiongate Capital Management ("Liongate"), a global alternative investment boutique based inLondon andNew York . Liongate is focused on managing portfolios of hedge funds and had$1.4 billion in AUM at the time of acquisition. Liongate is accounted for on the equity method within thePrincipal Global Investors segment.AFP Cuprum S.A. OnFebruary 4, 2013 , we finalized the purchase of Cuprum, a premier pension manager inChile . As a result of the public tender offer, we initially acquired a 91.55% ownership stake in Cuprum for a purchase price of$1.3 billion . Cuprum had$34.3 billion in AUM at the time of acquisition and is consolidated within thePrincipal International segment on a one-month lag. For additional information, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 2, Acquisitions."First Dental Health . OnNovember 1, 2012 , we finalized the purchase of a 100% interest inFirst Dental Health , aCalifornia based independent dental preferred provider organization.First Dental Health is consolidated within theU.S. Insurance Solutions segment. Claritas Administração de Recursos Ltda./Claritas Investments, Ltd. OnApril 2, 2012 , we finalized the purchase of a 60% indirect ownership inClaritas , a leading Brazilian mutual fund and asset management company. TheSao Paulo -based company manages equity funds, balanced funds, managed accounts and other strategies for affluent clients and institutions through its multi-channel distribution network.Claritas had$1.8 billion in AUM at the time of acquisition and is consolidated within thePrincipal International segment. 90 --------------------------------------------------------------------------------
Table of Contents Other Individual Life Insurance Amortization. During the first quarter of 2012, our individual life insurance business changed its basis for amortizing DAC and other actuarial balances on a portion of our universal life insurance products. The actuarial balances for these products are now amortized based on estimated gross revenues instead of estimated gross profits. This change required an unlocking of the actuarial balances to reflect the pattern of estimated gross revenues, which resulted in volatility within certain income statement line items. Specifically, fee revenues decreased$46.6 million ; benefits, claims and settlement expenses increased$87.9 million ; and operating expenses decreased$139.6 million . However, on a net basis the impact was a net gain of$3.3 million after-tax, which is not material. Group Medical Insurance Business. OnSeptember 30, 2010 , we announced our decision to exit the group medical insurance business (insured and administrative services only) and entered into an agreement withUnited Healthcare Services, Inc. to renew group medical insurance coverage for our customers. The exiting of the group medical insurance business does not qualify for discontinued operations treatment under U.S. GAAP. Therefore, the results of operations for the group medical insurance business are still included in our consolidated income from continuing operations. With the exception of corporate overhead, amounts related to our group medical insurance business previously included in segment operating earnings have been removed from operating earnings for all periods presented and are reported as other after-tax adjustments. The operating revenues associated with our exited group medical insurance business were$0.4 million and$4.0 million for the three months endedJune 30, 2013 and 2012, respectively, and$4.0 million and$22.9 million for the six months endedJune 30, 2013 and 2012, respectively. The other after-tax adjustments associated with the after-tax earnings (loss) of our exited group medical insurance business were$(1.5) million and$(4.0) million for the three months endedJune 30, 2013 and 2012, respectively, and$(0.1) million and$(5.5) million for the six months endedJune 30, 2013 and 2012, respectively.
Fluctuations in Foreign Currency to U.S. Dollar Exchange Rates
Fluctuations in foreign currency to U.S. dollar exchange rates for countries in which we have operations can affect reported financial results. In years when foreign currencies weaken against the U.S. dollar, translating foreign currencies into U.S. dollars results in fewer U.S. dollars to be reported. When foreign currencies strengthen, translating foreign currencies into U.S. dollars results in more U.S. dollars to be reported. Foreign currency exchange rate fluctuations create variances in our financial statement line items but have not had a material impact on our consolidated financial results.Principal International segment operating earnings were positively impacted by$0.1 million and negatively impacted by$1.5 million for the three and six months endedJune 30, 2013 , respectively, as a result of fluctuations in foreign currency to U.S. dollar exchange rates. For a discussion of our approaches to managing foreign currency exchange rate risk, see Item 3. "Quantitative and Qualitative Disclosures About Market Risk - Foreign Currency Risk."
Stock-Based Compensation Plans
For information related to our Stock-Based Compensation Plans, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 12, Stock-Based Compensation Plans."
Employee and Agent Benefits Expense
The 2013 annual defined benefit pension expense for substantially all of our employees and certain agents is expected to be$143.3 million pre-tax, which is a$21.0 million increase from the 2012 pre-tax pension expense of$122.3 million . This increase is primarily due to a decrease in the discount rate from 5.15% for 2012 to 4.00% for 2013. Also, the expected long-term return on plan assets used to develop the 2013 expense decreased to 7.50% from 8.00% used in 2012. Pre-tax pension expense of$35.8 million and$71.5 million was reflected in the determination of net income for the three and six months endedJune 30, 2013 , respectively. The 2013 annual other postemployment benefit ("OPEB") plan expense (income) for employees and certain agents is expected to be$(47.0) million pre-tax, which is an$8.2 million decrease from the 2012 pre-tax OPEB income of$(55.2) million . The weighted average expected long-term return on plan assets used to develop the expense (income) in 2013 decreased to 5.62% from 7.30%, which was based on weighted average expected long-term asset returns for the medical, life and long-term care plans. The expected long-term rates for the medical, life and long-term care plans were 5.40%, 7.75% and 5.85%, respectively. The expected rate of return for the medical plans was reduced to 5.40% to reflect the after-tax return on the plan assets resulting from the decision to have taxes paid by the trust instead of Principal Life. The discount rate used to develop the 2013 expense (income) decreased to 4.00%, down from the 5.15% discount rate used in 2012. The pre-tax expense (income) of$(11.7) million and$(23.4) million was reflected in the determination of net income for the three and six months endedJune 30, 2013 , respectively. 91 --------------------------------------------------------------------------------
Table of Contents Recent Accounting Changes For recent accounting changes, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 1, Nature of Operations and Significant Accounting Policies" under the captions, "Revisions of Previously Issued Financial Statements" and "Recent Accounting Pronouncements." Results of Operations The following table presents summary consolidated financial information for the periods indicated: For the three months ended June 30, For the six months ended June 30, Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Revenues: Premiums and other considerations$ 737.2 $ 681.3 $ 55.9 $ 1,431.9 $ 1,361.1 $ 70.8 Fees and other revenues 803.8 636.1 167.7 1,537.4 1,234.1 303.3 Net investment income 749.7 801.0 (51.3 ) 1,539.0 1,625.8 (86.8 ) Net realized capital gains (losses), excluding impairment losses on available-for-sale securities (53.4 ) 32.2 (85.6 ) (79.8 ) 54.3 (134.1 ) Total other-than-temporary impairment losses on available-for-sale securities (24.6 ) (49.1 ) 24.5 (69.3 ) (82.8 ) 13.5 Other-than-temporary impairment losses on fixed maturities, available-for-sale reclassified to (from) other comprehensive income (2.1 ) 17.1 (19.2 ) 18.1 22.0 (3.9 ) Net impairment losses on available-for-sale securities (26.7 ) (32.0 ) 5.3 (51.2 ) (60.8 ) 9.6 Net realized capital gains (losses) (80.1 ) 0.2 (80.3 ) (131.0 ) (6.5 ) (124.5 ) Total revenues 2,210.6 2,118.6 92.0 4,377.3 4,214.5 162.8 Expenses: Benefits, claims and settlement expenses 1,095.7 1,110.0 (14.3 ) 2,190.2 2,322.5 (132.3 ) Dividends to policyholders 47.5 49.5 (2.0 ) 95.8 99.8 (4.0 ) Operating expenses 801.8 729.6 72.2 1,597.5 1,284.7 312.8 Total expenses 1,945.0 1,889.1 55.9 3,883.5 3,707.0 176.5 Income before income taxes 265.6 229.5 36.1 493.8 507.5 (13.7 ) Income taxes 29.0 50.9 (21.9 ) 67.2 107.6 (40.4 ) Net income 236.6 178.6 58.0 426.6 399.9 26.7 Net income attributable to noncontrolling interest 6.0 2.7 3.3 9.5 11.9 (2.4 ) Net income attributable to Principal Financial Group, Inc. 230.6 175.9 54.7 417.1 388.0 29.1 Preferred stock dividends 8.3 8.3 - 16.5 16.5 - Net income available to common stockholders$ 222.3 $ 167.6 $ 54.7 $ 400.6 $ 371.5 $ 29.1
Three Months Ended
Net Income Available to Common Stockholders
Net income available to common stockholders increased primarily due to higher earnings in our Retirement and Investor Services segment stemming from an increase in fees as a result of positive equity market performance and growth in the business. In addition, net income available to common stockholders increased due to the Cuprum acquisition inChile . These increases in net income available to common stockholders were partially offset by an after-tax increase in net realized capital losses. 92
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Table of Contents Total Revenues Premiums increased$30.8 million for the Retirement and Investor Services segment primarily due to an increase in sales of single premium group annuities with life contingencies. The single premium product, which is typically used to fund defined benefit plan terminations, can generate large premiums from very few customers and therefore tends to vary from period to period. In addition, premiums increased$13.8 million for thePrincipal International segment primarily due to higher sales of single premium annuities with life contingencies inChile . Furthermore, premiums increased$11.1 million for theU.S. Insurance Solutions segment primarily due to growth in our specialty benefits insurance business. Fee revenues increased$78.2 million for the Retirement and Investor Services segment primarily due to an increase in average account values, which resulted from positive equity market performance and growth in the business. In addition, fee revenues increased$61.9 million for thePrincipal International segment primarily due to the Cuprum acquisition inChile . Furthermore, fee revenues increased$28.5 million for thePrincipal Global Investors segment largely due to higher fee revenues as a result of increased AUM.
Net investment income decreased primarily due to lower investment yields in our U.S. operations. For additional information, see "Investments - Investment Results."
Net realized capital gains (losses) can be volatile due to other-than-temporary impairments of invested assets, mark-to-market adjustments of certain invested assets and our decision to sell invested assets. Net realized capital losses increased primarily due to losses versus gains on the GMWB embedded derivatives, including losses versus gains from changes in the spread reflecting our own creditworthiness, and related hedging instruments, and due to losses versus gains on derivatives not designated as hedging instruments. For additional information, see "Investments - Investment Results." Total Expenses Benefits, claims and settlement expenses decreased$25.8 million for the Retirement and Investor Services segment primarily due to a decrease in cost of interest credited in our investment only business and resulting from a lower interest rate environment. Partially offsetting this decrease was a$9.4 million increase in benefits, claims and settlement expenses for theU.S. Insurance Solutions segment primarily due to an increase in reserves resulting from a lower interest rate environment.
Operating expenses increased
Income Taxes The effective income tax rates were 11% and 22% for the three months endedJune 30, 2013 and 2012, respectively. The effective income tax rate for the three months endedJune 30, 2013 , was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, a Chilean tax benefit resulting from a foreign currency loss on a U.S. denominated loan and the presentation of taxes on our share of earnings generated from equity method investments reflected in net investment income. The effective income tax rate for the three months endedJune 30, 2012 , was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, the presentation of taxes on our share of earnings generated from equity method investments reflected in net investment income and the interest exclusion from taxable income. The effective income tax rate decreased to 11% from 22% for the three months endedJune 30, 2013 and 2012, respectively, primarily due to a 2013 Chilean tax benefit resulting from a foreign currency loss on a U.S. denominated loan and increased income tax deductions allowed for corporate dividends received.
Six Months Ended
Net Income Available to Common Stockholders
Net income available to common stockholders increased primarily due to higher earnings in our Retirement and Investor Services segment stemming from an increase in fees as a result of positive equity market performance and growth in the business. In addition, net income available to common stockholders increased due to the Cuprum acquisition inChile . These increases in net income available to common stockholders were partially offset by an after-tax increase in net realized capital losses. 93
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Table of Contents Total Revenues Premiums increased$43.4 million for the Retirement and Investor Services segment primarily due to an increase in sales of single premium group annuities with life contingencies. In addition, premiums increased$25.4 million for theU.S. Insurance Solutions segment primarily due to growth as a result of strong sales and continued recovery in employment and salary trends. Fee revenues increased$128.0 million for the Retirement and Investor Services segment primarily due to an increase in average account values, which resulted from positive equity market performance and growth in the business. In addition, fee revenues increased$88.5 million for thePrincipal International segment primarily due to the Cuprum acquisition inChile and higher investment management fees driven by higher average AUM inMexico . Furthermore, fee revenues increased$73.5 million for theU.S. Insurance Solutions segment primarily due to unlocking of unearned revenue associated with the change in basis for amortizing DAC and other actuarial balances in the first quarter of 2012 and growth in our universal life and variable universal life lines of business. Net investment income decreased primarily due to lower investment yields in our U.S. operations and lower inflation-based investments returns on average invested assets and cash as a result of lower inflation inChile . For additional information, see "Investments - Investment Results." Net realized capital gains (losses) can be volatile due to other-than-temporary impairments of invested assets, mark-to-market adjustments of certain invested assets and our decision to sell invested assets. Net realized capital losses increased primarily due to losses versus gains on the GMWB embedded derivatives, including losses versus gains from changes in the spread reflecting our own creditworthiness, and related hedging instruments, and due to losses versus gains on derivatives not designated as hedging instruments. For additional information, see "Investments - Investment Results." Total Expenses Benefits, claims and settlement expenses decreased$49.0 million for the Retirement and Investor Services segment primarily due to a decrease in cost of interest credited in our investment only business resulting from a lower interest rate environment. In addition, benefits, claims and settlement expenses decreased$41.1 million for thePrincipal International segment primarily due to lower inflation-based interest crediting rates to customers partially offset by the strengthening of the Chilean peso against the U.S. dollar. Furthermore, benefits, claims and settlement expenses decreased$39.3 million for theU.S. Insurance Solutions segment primarily due to unlocking associated with the change in basis for amortizing DAC and other actuarial balances in 2012. Operating expenses increased$160.8 million for theU.S. Insurance Solutions segment primarily due to unlocking associated with the change in basis for amortizing DAC and other actuarial balances in 2012. In addition, operating expenses increased$87.6 million for the Retirement and Investor Services segment primarily due to an increase in non-deferrable distribution costs resulting from growth in the business and higher sub-advisory fees stemming from positive equity market performance. Furthermore, operating expenses also increased$50.0 million for thePrincipal International segment primarily due to acquisition and growth initiatives across the segment. Income Taxes The effective income tax rates were 14% and 21% for the six months endedJune 30, 2013 and 2012, respectively. The effective income tax rate for the six months endedJune 30, 2013 , was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, the presentation of taxes on our share of earnings generated from equity method investments in net investment income and a Chilean tax benefit resulting from a foreign currency loss on a U.S. denominated loan. The effective income tax rate for the six months endedJune 30, 2012 , was lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received, the presentation of taxes on our share of earnings generated from equity method investments in net investment income and the interest exclusion from taxable income. The effective income tax rate decreased to 14% from 21% for the six months endedJune 30, 2013 and 2012, respectively, primarily due to a 2013 Chilean tax benefit resulting from a foreign currency loss on a U.S. denominated loan and increased income tax deductions allowed for corporate dividends received.
Results of Operations by Segment
For results of operations by segment see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 11, Segment Information."
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Retirement and Investor Services Segment
Retirement and Investor Services Segment Summary Financial Data
Net revenue is a key metric used to understand Retirement and Investor Services ("RIS") earnings growth. Net revenue is defined as operating revenues less benefits, claims and settlement expenses less dividends to policyholders. Net revenue from our Accumulation products is primarily fee based and is impacted by changes in the equity markets. Net revenue from our Guaranteed products is driven by our ability to earn an investment spread. Accumulation net revenue has grown due to improvement in the equity markets as well as growth in the block of business. Guaranteed net revenue has increased due to improvement in variable investment income.
The following table presents the RIS net revenue for the periods indicated:
For the three months endedJune 30 ,
For the six months ended
Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Net revenue: Accumulation$ 578.4 $ 496.0 $ 82.4 $ 1,138.3 $ 989.5 $ 148.8 Guaranteed 48.7 42.0 6.7 97.4 83.2 14.2 Total Retirement and Investor Services$ 627.1 $ 538.0 $ 89.1 $ 1,235.7 $ 1,072.7 $ 163.0
Retirement and Investor Services Segment Summary Financial Data
The following table presents certain summary financial data relating to the RIS segment for the periods indicated:
For the three months endedJune 30 ,
For the six months ended
Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Operating revenues: Premiums and other considerations$ 204.0 $ 173.2 $ 30.8 $ 370.1 $ 326.7 $ 43.4 Fees and other revenues 446.7 368.5 78.2 867.2 739.2 128.0 Net investment income 498.1 539.5 (41.4 ) 1,013.8 1,070.4 (56.6 ) Total operating revenues 1,148.8 1,081.2 67.6 2,251.1 2,136.3 114.8 Expenses: Benefits, claims and settlement expenses, including dividends to policyholders 521.7 543.2 (21.5 ) 1,015.4 1,063.6 (48.2 ) Operating expenses 400.1 356.6 43.5 794.5 704.2 90.3 Total expenses 921.8 899.8 22.0 1,809.9 1,767.8 42.1 Operating earnings before income taxes 227.0 181.4 45.6 441.2 368.5 72.7 Income taxes 54.7 39.7 15.0 98.9 83.2 15.7 Operating earnings$ 172.3 $ 141.7 $ 30.6 $ 342.3 $ 285.3 $ 57.0
Three Months Ended
Operating Earnings Operating earnings increased$26.4 million in our Accumulation business primarily due to higher fees stemming from positive equity market performance and growth in the business. The increase in Accumulation fee revenue was partially offset by an increase in non-deferrable distribution costs, higher sub-advisory fees and to a lesser extent, staff-related costs. Net Revenue
Net revenue increased
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Operating expenses increased
Income Taxes The effective income tax rates for the segment were 24% and 22% for the three months endedJune 30, 2013 and 2012, respectively. The effective income tax rates were lower than the U.S. statutory rate primarily due to income tax deductions allowed for corporate dividends received and the interest exclusion from taxable income.
Six Months Ended
Operating Earnings Operating earnings increased$48.0 million in our Accumulation business primarily due to higher fees stemming from positive equity market performance and growth in the business. The increase in Accumulation fee revenue was partially offset by an increase in non-deferrable distribution costs, higher sub-advisory fees and to a lesser extent, staff-related costs. Net Revenue
Net revenue increased
Operating Expenses
Operating expenses increased
Income Taxes
The effective income tax rates for the segment were 22% and 23% for the six months ended
Principal Global Investors Segment
Principal Global Investors Segment Summary Financial Data
AUM is a key indicator of earnings growth for ourPrincipal Global Investors segment, as AUM is the base by which we generate revenues. Net cash flow and market performance are the two main drivers of AUM growth. Net cash flow reflects our ability to attract and retain client deposits. Market performance reflects equity, fixed income and real estate market performance. The percentage growth in earnings of the segment will generally track with the percentage growth in AUM. This trend may vary due to changes in business and/or product mix. 96
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The following table presents the AUM rollforward for assets managed by
For the three months ended June 30, For the six months ended June 30, 2013 2012 2013 2012 (in billions) AUM, beginning of period $ 273.0 $ 242.2 $ 263.2 $ 227.8 Net cash flow (0.9 ) 2.9 1.4 6.6 Investment performance (1.6 ) (0.9 ) 8.3 11.3 Operations acquired (1) 1.4 - 1.4 - Other (0.7 ) (0.3 ) (3.1 ) (1.8 ) AUM, end of period $ 271.2 $ 243.9 $ 271.2 $ 243.9
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(1) Reflects the acquisition of Liongate in
The following table presents certain summary financial data relating to the
For the three months endedJune 30 ,
For the six months ended
Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Operating revenues: Fees and other revenues$ 167.0 $ 138.5 $ 28.5 $ 315.2 $ 272.6 $ 42.6 Net investment income 1.2 2.6 (1.4 ) 6.7 6.6 0.1 Total operating revenues 168.2 141.1 27.1 321.9 279.2 42.7 Expenses: Total expenses 120.0 111.4 8.6 239.3 222.1 17.2 Operating earnings before income taxes and noncontrolling interest 48.2 29.7 18.5 82.6 57.1 25.5 Income taxes 15.9 8.9 7.0 27.4 18.9 8.5 Operating earnings attributable to noncontrolling interest 3.3 2.6 0.7 5.9 3.8 2.1
Operating earnings
49.3$ 34.4 $ 14.9
Three Months Ended
Operating Earnings Operating earnings increased primarily due to higher fee revenues driven by an increase in average AUM as well as a performance fee realized in our real estate business. These increases were partially offset by higher variable compensation costs resulting from increased business. Income Taxes The effective income tax rates for the segment were 33% and 30% for the three months endedJune 30, 2013 and 2012, respectively. The effective income tax rates were lower than the U.S. statutory rate primarily due to the inclusion of income attributable to noncontrolling interest in operating earnings before income taxes with no corresponding change in income taxes reported by us as the controlling interest.
Six Months Ended
Operating Earnings Operating earnings increased primarily due to higher fee revenues driven by an increase in average AUM as well as a performance fee realized in our real estate business. 97
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Table of Contents Income Taxes The effective income tax rate for the segment was 33% for both the six months endedJune 30, 2013 and 2012. The effective income tax rate was lower than the U.S. statutory rate primarily due to the inclusion of income attributable to noncontrolling interest in operating earnings before income taxes with no corresponding change in income taxes reported by us as the controlling interest.
Principal International Segment
Principal International Segment Summary Financial Data
AUM is generally a key indicator of earnings growth for the segment, as AUM is the base by which we can generate local currency profits. The Cuprum business inChile differs in that fees generated are determined by salary levels of the mandatory retirement customers, with deposits subject to an annual cap, as opposed to asset levels. Net customer cash flow and market performance are the two main drivers of local currency AUM growth. Net customer cash flow reflects our ability to attract and retain client deposits. Market performance reflects the investment returns on our underlying AUM. Our financial results are also impacted by fluctuations of the foreign currency to U.S. dollar exchange rates for the countries in which we have business. AUM of our foreign subsidiaries is translated into U.S. dollar equivalents at the end of the reporting period using the spot foreign exchange rates. Revenue and expenses for our foreign subsidiaries are translated into U.S. dollar equivalents at the average foreign exchange rates for the reporting period. The following table presents thePrincipal International segment AUM rollforward for the periods indicated: For the three months ended June 30, For the six months ended June 30, 2013 2012 2013 2012 (in billions) AUM, beginning of period $ 107.4 $ 59.2 $ 69.3 $ 52.8 Net cash flow 2.2 2.3 4.7 4.6 Investment performance (0.2 ) 1.4 0.3 3.6 Operations acquired (1) - 1.8 34.3 1.8 Effect of exchange rates (6.7 ) (4.3 ) (5.7 ) (2.3 ) Other 0.2 (0.1 ) - (0.2 ) AUM, end of period $ 102.9 $ 60.3 $ 102.9 $ 60.3
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(1) Reflects the
Net revenue is a key metric used to understand the earnings growth for the
For the three months endedJune 30 ,
For the six months ended
Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Net revenue$ 152.1 $ 88.5 $ 63.6 $ 271.0 $ 180.7 $ 90.3
Net revenue increased primarily due to the Cuprum acquisition in
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The following table presents certain summary financial data of the
For the three months ended June 30, For the six months ended June 30, Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Operating revenues: Premiums and other considerations$ 78.3 $ 64.5 $ 13.8 $ 149.8 $ 148.3 $ 1.5 Fees and other revenues 112.4 50.5 61.9 189.2 100.7 88.5 Net investment income 84.4 95.6 (11.2 ) 183.6 224.1 (40.5 ) Total operating revenues 275.1 210.6 64.5 522.6 473.1 49.5 Expenses: Benefits, claims and settlement expenses 123.0 122.1 0.9 251.6 292.4 (40.8 ) Operating expenses 86.7 56.1 30.6 155.3 105.4 49.9 Total expenses 209.7 178.2 31.5 406.9 397.8 9.1 Operating earnings before income taxes and noncontrolling interest 65.4 32.4 33.0 115.7 75.3 40.4 Income taxes (benefits) 4.5 0.8 3.7 9.5 (0.3 ) 9.8 Operating earnings attributable to noncontrolling interest 2.6 0.1 2.5 3.3 - 3.3 Operating earnings$ 58.3 $ 31.5 $ 26.8 $ 102.9 $ 75.6 $ 27.3
Three Months Ended
Operating Earnings
Operating earnings increased primarily due to the Cuprum acquisition.
Operating Revenues
Premiums increased
Fees and other revenues increased primarily due to the Cuprum acquisition.
Net investment income decreased primarily due to lower inflation-based investment returns on average invested assets and cash as a result of lower inflation in
Total Expenses Benefits, claims and settlement expenses increased primarily due to higher sales of single premium annuities with life contingencies inChile , the strengthening of the Chilean peso against the U.S. dollar and higher inflation inMexico . These increases were partially offset by lower inflation-based interest crediting rates to customers inChile .
Operating expenses increased primarily due to the Cuprum acquisition.
Income Taxes The effective income tax rates for the segment were 7% and 2% for the three months endedJune 30, 2013 and 2012, respectively. The effective income tax rates were lower than the U.S. statutory rate primarily due to the presentation of taxes on our share of earnings generated from our equity method investments. Specifically, our share of earnings generated from equity method investments, net of foreign taxes incurred, are reported within net investment income whereas any residual U.S. tax expense or benefit related to equity method investments is reported in income taxes. Lower tax rates of foreign jurisdictions also contributed to the lower effective income tax rates. The effective income tax rate increased to 7% from 2% for the three months endedJune 30, 2013 and 2012, respectively, primarily due to the Cuprum acquisition inChile , which increased our distribution of operating earnings from our consolidated entities compared to our equity method investments. This was partially offset by tax benefits in foreign jurisdictions. 99
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Six Months Ended
Operating Earnings Operating earnings increased primarily due to the Cuprum acquisition inChile partially offset by lower inflation-based investment returns on average invested assets and cash as a result of lower inflation inChile . Operating Revenues
Premiums increased
Fees and other revenues increased primarily due to the Cuprum acquisition in
Net investment income decreased primarily due to lower inflation-based investment returns on average invested assets and cash as a result of lower inflation partially offset by the Cuprum acquisition in
Total Expenses
Benefits, claims and settlement expenses decreased
Operating expenses increased primarily due to acquisition and growth initiatives across the segment.
Income Taxes The effective income tax rates for the segment were 8% and 0% for the six months endedJune 30, 2013 and 2012, respectively. The effective income tax rates were lower than the U.S. statutory rate primarily due to taxes on our share of earnings generated from our equity method investments. Specifically, our share of earnings generated from equity method investments, net of foreign taxes incurred, are reported within net investment income whereas any residual U.S. tax expense or benefit related to equity method investments is reported in income taxes. Lower tax rates of foreign jurisdictions also contributed to the lower effective income tax rates. The effective income tax rate increased to 8% from 0% for the six months endedJune 30, 2013 and 2012, respectively, primarily due to the Cuprum acquisition inChile , which increased our distribution of operating earnings from our consolidated entities compared to our equity method investments.
U.S. Insurance Solutions Segment
Individual Life Insurance Trends
Our life insurance premium and fees are influenced by both economic and industry trends. For several years, we focused our product development and marketing efforts primarily on universal life and variable universal life products. However, due to the recent declining interest rate environment, we have focused on less interest-sensitive products. Beginning in 2011, with the launch of new term products, we have increased sales of traditional products while continuing to experience strong growth in universal and variable universal life products.
The following table provides a summary of our individual universal and variable universal life insurance fee revenues and our individual traditional life insurance premiums for the periods indicated:
For the three months ended For the six months ended June 30, June 30, 2013 2012 2013 2012 (in millions) Universal and variable universal life insurance fee revenues (1)$ 130.8 $ 120.5 $ 267.5 $ 193.2 Traditional life insurance premiums 130.5 125.8 258.2 249.0
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(1) Fee revenues for the six months ended
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Specialty Benefits Insurance Trends
Premium and fees in our specialty benefits insurance business are also influenced by economic and industry trends. Premium and fees have risen slower in recent years due to more moderate increases in underlying salaries and lower membership growth in existing group contracts.
The following table provides a summary of our specialty benefits insurance premium and fees for the periods indicated:
For the three months ended For the six months ended June 30, June 30, 2013 2012 2013 2012 (in millions) Premium and fees: Group dental and vision insurance$ 146.0 $ 144.2 $ 291.4 $ 287.8 Group life insurance 83.0 82.9 166.3 163.8 Group disability insurance 77.6 74.3 150.7 143.6 Individual disability insurance 63.5 57.9 125.8 115.0 Wellness 2.3 2.2 4.9 5.0
U.S. Insurance Solutions Segment Summary Financial Data
There are several key indicators for earnings growth in ourU.S. Insurance Solutions segment. The ability of our distribution channels to generate new sales and retain existing business drives growth in our premium and fees. Our earnings growth also depends on our ability to price our products at a level that enables us to earn a margin over the cost of providing benefits and the expense of acquiring and administering those products. Factors impacting pricing decisions include competitive conditions, economic trends, persistency, our ability to assess and manage trends in mortality and morbidity and our ability to manage operating expenses.
The following table presents certain summary financial data relating to the
For the three months endedJune 30 ,
For the six months ended
Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Operating revenues: Premiums and other considerations$ 454.7 $ 443.6 $ 11.1 $ 908.8 $ 883.4 $ 25.4 Fees and other revenues (1) 144.0 134.1 9.9 295.6 221.4 74.2 Net investment income 174.3 173.8 0.5 346.6 343.7 2.9 Total operating revenues 773.0 751.5 21.5 1,551.0 1,448.5 102.5 Expenses: Benefits, claims and settlement expenses (1) 460.1 443.3 16.8 937.6 970.5 (32.9 ) Dividends to policyholders 47.1 49.0 (1.9 ) 95.1 98.8 (3.7 ) Operating expenses (1) 196.1 185.8 10.3 396.8 231.6 165.2 Total expenses 703.3 678.1 25.2 1,429.5 1,300.9 128.6 Operating earnings before income taxes 69.7 73.4 (3.7 ) 121.5 147.6 (26.1 ) Income taxes 22.5 23.2 (0.7 ) 38.6 47.2 (8.6 ) Operating earnings$ 47.2 $ 50.2 $ (3.0 ) $ 82.9 $ 100.4 $ (17.5 )
-------------------------------------------------------------------------------- (1) For further details related to the impact associated with the change in basis for amortizing DAC and other actuarial balances on results for the six months endedJune 30, 2012 , see "Transactions Affecting Comparability of Results of Operations - Individual Life Insurance Amortization."
Three Months Ended
Operating Earnings
Operating earnings in our individual life insurance business decreased
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Table of Contents Operating Revenues Premiums increased$10.4 million in our specialty benefits insurance business primarily due to growth as a result of strong sales in the block of business and continued recovery in employment and salary trends. Fees and other revenues increased$9.5 million in our individual life insurance business primarily due to growth in the universal life and variable universal life lines of business. Total Expenses
Benefits, claims and settlement expenses increased
Operating expenses increased
Income Taxes The effective income tax rate for the segment was 32% for both the three months endedJune 30, 2013 and 2012. The effective income tax rate was lower than the U.S. statutory rate primarily due to interest exclusion from taxable income and income tax deductions allowed for corporate dividends received.
Six Months Ended
Operating Earnings Operating earnings in our individual life insurance business decreased$22.9 million primarily due to higher claims net of reinsurance and an increase in reserves resulting from a lower interest rate environment. Operating earnings in our specialty benefits insurance business increased$5.4 million primarily due to improved claim experience partially offset by higher staff-related costs, including pension and other postretirement benefit expense. Operating Revenues Premiums increased$22.9 million in our specialty benefits insurance business primarily due to growth and strong sales in the block of business and continued recovery in employment and salary trends. Fees and other revenues increased$73.3 million in our individual life insurance business primarily due to the unlocking of unearned revenue associated with the change in basis for amortizing DAC and other actuarial balances in the first quarter of 2012 and growth in our universal life and variable universal life lines of business. Total Expenses Total expenses increased$110.1 million in our individual life insurance business primarily due to lower total expenses in first quarter 2012 associated with the change in basis for amortizing DAC and other actuarial balances, growth in the block of business and higher claims net or reinsurance. Income Taxes The effective income tax rate for the segment was 32% for both the six months endedJune 30, 2013 and 2012. The effective income tax rate was lower than the U.S. statutory rate primarily due to interest exclusion from taxable income and income tax deductions allowed for corporate dividends received. 102 --------------------------------------------------------------------------------
Table of Contents Corporate Segment
Corporate Segment Summary Financial Data
The following table presents certain summary financial data relating to the Corporate segment for the periods indicated:
For the three months endedJune 30 ,
For the six months ended
Increase Increase 2013 2012 (decrease) 2013 2012 (decrease) (in millions) Total operating revenues$ (53.4 ) $ (48.1 ) $ (5.3 ) $ (96.6 ) $ (93.4 ) $ (3.2 ) Total expenses (2.5 ) (11.1 ) 8.6 0.6 (12.0 ) 12.6 Operating loss before income taxes, preferred stock dividends and noncontrolling interest (50.9 ) (37.0 ) (13.9 ) (97.2 ) (81.4 ) (15.8 ) Income tax benefits (23.9 ) (14.5 ) (9.4 ) (41.3 ) (28.3 ) (13.0 ) Preferred stock dividends 8.3 8.3 - 16.5 16.5 - Operating earnings (loss) attributable to noncontrolling interest 0.1 (0.1 ) 0.2 0.3 (0.1 ) 0.4 Operating loss$ (35.4 ) $ (30.7 ) $ (4.7 ) $ (72.7 ) $ (69.5 ) $ (3.2 )
Three Months Ended
Operating Loss
The operating loss increased due to litigation expenses and higher after-tax interest expense on corporate debt.
Six Months Ended
Operating Loss The operating loss increased primarily due to higher after-tax interest expense on corporate debt. The one-time costs associated with the first quarter 2013 acquisition of Cuprum were largely offset by interest income earned on the assets used to fund the Cuprum acquisition.
Liquidity and Capital Resources
Liquidity and capital resources represent the overall strength of a company and its ability to generate strong cash flows, borrow funds at a competitive rate and raise new capital to meet operating and growth needs. Our legal entity structure has an impact on our ability to meet cash flow needs as an organization. Following is a simplified organizational structure. [[Image Removed]] Liquidity Our liquidity requirements have been and will continue to be met by funds from consolidated operations as well as the issuance of commercial paper, common stock, debt or other capital securities and borrowings from credit facilities. We believe that cash flows from these sources are sufficient to satisfy the current liquidity requirements of our operations, including reasonably foreseeable contingencies. 103
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We maintain a level of cash and securities which, combined with expected cash inflows from investments and operations, is believed to be adequate to meet anticipated short-term and long-term payment obligations. We will continue our prudent capital management practice of regularly exploring options available to us to maximize capital flexibility, including accessing the capital markets and careful attention to and management of expenses. Our liquidity is supported by a portfolio of U.S. government and agency and residential pass-through government-backed securities, of which we held$3.8 billion as ofJune 30, 2013 , that may be utilized to bolster our liquidity position, as collateral for secured borrowing transactions with various third parties or by disposing of the securities in the open market, if needed. As ofJune 30, 2013 , approximately$9.9 billion , or 99%, of our institutional guaranteed investment contracts and funding agreements cannot be redeemed by contractholders prior to maturity. Our life insurance and annuity liabilities contain provisions limiting early surrenders. As ofJune 30, 2013 andDecember 31, 2012 , we had short-term credit facilities with various financial institutions in an aggregate amount of$1,113.0 million and$905.0 million , respectively. As ofJune 30, 2013 andDecember 31, 2012 , we had$175.3 million and$40.8 million , respectively, of outstanding borrowings, with no assets pledged as support as ofJune 30, 2013 . Our credit facilities include a$500.0 million 4-year facility that matures inMarch 2016 , with PFG, PFS and Principal Life as co-borrowers. We also have a$300.0 million 364-day facility for Principal Life only that was refinanced inApril 2013 . Also inApril 2013 , we added a$200.0 million 3-year facility with PFG, PFS,Principal Life and Principal Financial Services V (UK) LTD as borrowers. These credit facilities are committed facilities and provide 100% back-stop support for our commercial paper program. The 4-year facility is supported by eighteen banks; the 364-day facility and 3-year facility are supported by fifteen banks, most, if not all, of which have other relationships with us. Due to the financial strength and the strong relationships we have with these providers, we are comfortable there is a very low risk the financial institutions would be unable or unwilling to fund these facilities. The Holding Companies:Principal Financial Group, Inc. andPrincipal Financial Services, Inc. The principal sources of funds available to our parent holding company, PFG, to meet its obligations, including the payments of dividends on common stock, debt service and the repurchase of stock, are dividends from subsidiaries as well as its ability to borrow funds at competitive rates and raise capital to meet operating and growth needs. The declaration and payment of common stock dividends by us is subject to the discretion of our Board of Directors and will depend on our overall financial condition, results of operations, capital levels, cash requirements, future prospects, receipt of dividends from Principal Life (as described below), risk management considerations and other factors deemed relevant by the Board. There are no significant restrictions that limit the payment of dividends by PFG, except those generally applicable to corporations incorporated inDelaware . Dividends from Principal Life, our primary subsidiary, are limited byIowa law. UnderIowa laws, Principal Life may pay dividends only from the earned surplus arising from its business and must receive the prior approval of the Insurance Commissioner of theState of Iowa ("the Commissioner") to pay stockholder dividends or make any other distribution if such distributions would exceed certain statutory limitations.Iowa law gives the Commissioner discretion to disapprove requests for distributions in excess of these limits. Extraordinary dividends include those made within the preceding twelve months that exceed the greater of (i) 10% of Principal Life's statutory policyholder surplus as of the previous year-end or (ii) the statutory net gain from operations from the previous calendar year. Based onDecember 31, 2012 , statutory results, the dividend limitation for Principal Life is approximately$472.0 million . No stockholder dividends were paid by Principal Life to its parent as ofJune 30, 2013 . Operations. Our primary consolidated cash flow sources are premiums from insurance products, pension and annuity deposits, asset management fee revenues, administrative services fee revenues, income from investments and proceeds from the sales or maturity of investments. Cash outflows consist primarily of payment of benefits to policyholders and beneficiaries, income and other taxes, current operating expenses, payment of dividends to policyholders, payments in connection with investments acquired, payments made to acquire subsidiaries, payments relating to policy and contract surrenders, withdrawals, policy loans, interest payments and repayment of short-term debt and long-term debt. Our investment strategies are generally intended to provide adequate funds to pay benefits without forced sales of investments. For a discussion of our investment objectives, strategies and a discussion of duration matching, see "Investments" as well as Item 3. "Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk." Cash Flows. Activity, as reported in our consolidated statements of cash flows, provides relevant information regarding our sources and uses of cash. The following discussion of our operating, investing and financing portions of the cash flows excludes cash flows attributable to the separate accounts. Net cash provided by operating activities was$783.6 million and$1,502.0 million for the six months endedJune 30, 2013 and 2012, respectively. From our insurance business, we typically generate positive cash flows from operating activities, as premiums collected from our insurance products and income received from our investments exceed acquisition costs, benefits paid, redemptions and operating expenses. These positive cash flows are then invested to support the obligations of our insurance and investment products and required capital supporting these products. Our cash flows from operating activities are affected by the timing of premiums, fees and investment income received and benefits and expenses paid. The decrease in cash provided by operating activities in 2013 compared to 104 --------------------------------------------------------------------------------
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2012 was primarily due to fluctuations in receivables and payables associated with the timing of settlements.
Net cash used in investing activities was$1,922.6 million and$826.8 million for the six months endedJune 30, 2013 and 2012, respectively. The increase in cash used in investing activities in 2013 compared to 2012 was primarily the result of the first quarter 2013 acquisition of Cuprum. Net cash used in financing activities was$1,927.7 million and$1,862.5 million for the six months endedJune 30, 2013 and 2012, respectively. The increase in cash used in financing activities was primarily due to net repayments of debt in 2013, as compared to net borrowings in 2012. This increase was partially offset by a decrease in cash used to acquire treasury stock in 2013. Shelf Registration. OnMay 24, 2011 , our shelf registration statement was filed with theSEC and became effective. The shelf registration replaces the shelf registration that had been in effect sinceJune 2008 . Under our current shelf registration, we have the ability to issue in unlimited amounts, unsecured senior debt securities or subordinated debt securities, junior subordinated debt, preferred stock, common stock, warrants, depository shares, stock purchase contracts and stock purchase units of PFG, trust preferred securities of three subsidiary trusts and guarantees by PFG of these trust preferred securities. Our wholly owned subsidiary, PFS, may guarantee, fully and unconditionally or otherwise, our obligations with respect to any non-convertible securities, other than common stock, described in the shelf registration. Preferred Stock Dividend Restrictions and Payments. The certificates of designation for the Series A and B Preferred Stock restrict the declaration of preferred dividends if we fail to meet specified capital adequacy, net income or stockholders' equity levels. As ofJune 30, 2013 , we have no preferred dividend restrictions. The dividend payments on our preferred stock are not mandatory or cumulative, as our Board of Directors approves each quarterly dividend payment.
Short-Term Debt. The components of short-term debt were as follows:
June 30, 2013 December 31, 2012 (in millions) Short-term credit facilities $ 135.3 $ - Other recourse short-term debt 40.0 40.8 Total short-term debt $ 175.3 $ 40.8
Long-Term Debt. As of
Stockholders' Equity. The following table summarizes our return of capital to common stockholders. June 30, 2013 December 31, 2012 (in millions) Dividends to stockholders$ (135.2 ) $ (231.3 ) Repurchase of common stock (91.4 ) (272.7 ) Total cash returned to stockholders$ (226.6 ) $ (504.0 )
For additional stockholders' equity information, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 9, Stockholders' Equity."
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The following table summarizes our capital structure:
June 30, 2013 December 31, 2012 (in millions) Debt: Short-term debt $ 175.3 $ 40.8 Long-term debt 2,578.6 2,671.3 Total debt 2,753.9 2,712.1 Equity excluding AOCI 9,303.9 9,043.1
Total capitalization excluding AOCI
30 % 30 % Debt to capitalization excluding AOCI 23 % 23 %
As of
Contractual Obligations and Contractual Commitments
As of
Off-Balance Sheet Arrangements
Variable Interest Entities. We have relationships with various types of special purpose entities and other entities where we have a variable interest as described in Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 3, Variable Interest Entities."
Guarantees and Indemnifications. As ofJune 30, 2013 , there have been no significant changes to guarantees and indemnifications sinceDecember 31, 2012 . For guarantee and indemnification information, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 8, Contingencies, Guarantees and Indemnifications" under the caption, "Guarantees and Indemnifications."
Financial Strength Rating and Credit Ratings
Our ratings are influenced by the relative ratings of our peers/competitors as well as many other factors including our operating and financial performance, asset quality, liquidity, asset/liability management, overall portfolio mix, financial leverage (i.e., debt), risk exposures, operating leverage, ratings and other factors.A.M. Best recently affirmed a stable outlook on the U.S. life insurance sector. Fitch and Standard & Poor's maintain a stable outlook, and Moody's maintains a negative outlook. Regardless of their published outlook on the sector, these rating agencies note that current challenges for the industry are the result of sustained low interest rates, global sovereign uncertainty, equity market volatility, and lingering unemployment and fiscal tightening. In early July, following a review of PFG and its subsidiaries under its revised criteria, Standard & Poor's affirmed the financial strength rating ofPrincipal Life and Principal National Life Insurance Company . The outlook was revised to 'stable' from 'negative'. The change in outlook reflects Standard & Poor's positive view of our solid operating performance, diversification by product line and geography, as well as financial leverage, fixed charge coverage and capital adequacy supportive of the ratings. In a semi-annual review completed in February, and after the close of the Cuprum acquisition, Fitch affirmed the financial strength ratings ofPrincipal Life and Principal National Life Insurance Company . The outlook was revised to 'negative' from 'rating watch negative'. The elimination of the 'rating watch negative' reflects the successful completion of the acquisition; the placement of the 'negative' outlook reflects the pressure on certain cash coverage and debt metrics as well as integration risk of the acquisition. 106 --------------------------------------------------------------------------------
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The following table summarizes our significant financial strength and debt ratings from the major independent rating organizations. The debt ratings shown are indicative ratings. Outstanding issuances are rated the same as indicative ratings unless otherwise noted. Actual ratings can differ from indicative ratings based on contractual terms. Standard & A.M. Best Fitch Poor's Moody'sPrincipal Financial Group Senior Unsecured Debt (1) a- BBB+ Baa1 Preferred Stock (2) bbb BBB- Baa3Principal Financial Services Senior Unsecured Debt a- BBB+ A3 Commercial Paper AMB-1 A-2 P-2Principal Life Insurance Company Insurer Financial Strength A+ AA- A+ Aa3 Issuer Credit Rating aa- Commercial Paper AMB-1+ A-1+ P-1 Surplus Notes a A- A2 Enterprise Risk Management Rating StrongPrincipal National Life Insurance Company Insurer Financial Strength A+ AA- A+ Aa3
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(1) Moody's has rated
(2) S&P has rated
Fair Value Measurement Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three levels for disclosure purposes. The fair value hierarchy gives the highest priority (Level 1) to quoted prices in active markets for identical assets or liabilities and gives the lowest priority (Level 3) to unobservable inputs. An asset or liability's classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. See Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 10, Fair Value Measurements" for further details, including a reconciliation of changes in Level 3 fair value measurements. As ofJune 30, 2013 , 35% of our net assets (liabilities) were Level 1, 62% were Level 2 and 3% were Level 3. Excluding separate account assets as ofJune 30, 2013 , 1% of our net assets (liabilities) were Level 1, 98% were Level 2 and 1% were Level 3. As ofDecember 31, 2012 , 41% of our net assets (liabilities) were Level 1, 55% were Level 2 and 4% were Level 3. Excluding separate account assets as ofDecember 31, 2012 , 2% of our net assets (liabilities) were Level 1, 97% were Level 2 and 1% were Level 3.
Changes in Level 3 Fair Value Measurements
Net assets (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as ofJune 30, 2013 , were$5,272.5 million as compared to$4,987.4 million as ofDecember 31, 2012 . The increase was primarily related to gains on other invested assets and real estate included in our separate account assets, as well as gains on bifurcated embedded derivatives in investment-type insurance contracts. Net assets (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as ofJune 30, 2012 , were$4,747.5 million as compared to$4,647.3 million as ofDecember 31, 2011 . The increase was primarily related to gains on other invested assets and real estate included in our separate account assets. This increase was largely offset by transfers out of Level 3 into Level 2 for certain fixed maturities, available-for-sale due to our obtaining prices from third party pricing vendors or using internal models based on substantially observable market information versus relying on broker quotes or utilizing significant unobservable inputs. Investments We had total consolidated assets as ofJune 30, 2013 , of$196,512.7 million , of which$67,781.5 million were invested assets. The rest of our total consolidated assets are comprised primarily of separate account assets for which we do not bear investment risk. 107
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Because we generally do not bear any investment risk on assets held in separate accounts, the discussion and financial information below does not include such assets.
Overall Composition of Invested Assets
Invested assets as ofJune 30, 2013 , were predominantly high quality and broadly diversified across asset class, individual credit, industry and geographic location. Asset allocation is determined based on cash flow and the risk/return requirements of our products. As shown in the following table, the major categories of invested assets are fixed maturities and commercial mortgage loans. The remainder is invested in other investments, residential mortgage loans, real estate and equity securities. In addition, policy loans are included in our invested assets. June 30, 2013 December 31, 2012 Carrying amount % of total Carrying
amount % of total ($ in millions) Fixed maturities: Public$ 34,612.1 51 %$ 36,136.2 52 % Private 15,169.3 22 15,429.8 22 Equity securities 772.0 1 389.3 1 Mortgage loans: Commercial 10,871.0 16 10,183.3 15 Residential 1,250.7 2 1,336.4 2 Real estate held for sale 131.0 - 87.0 - Real estate held for investment 1,133.8 2 1,093.3 2 Policy loans 865.3 1 864.9 1 Other investments 2,976.3 5 3,291.1 5 Total invested assets 67,781.5 100 % 68,811.3 100 % Cash and cash equivalents 1,110.5 4,177.2 Total invested assets and cash$ 68,892.0 $ 72,988.5 Investment Results Net Investment Income The following table presents the yield and investment income, excluding net realized capital gains and losses, for our invested assets for the periods indicated. We calculate annualized yields using a simple average of asset classes at the beginning and end of the reporting period. The yields for fixed maturities and equity securities are calculated using amortized cost and cost, respectively. All other yields are calculated using carrying amounts. For the three months ended June 30, Increase (decrease) For the six months ended June 30, Increase (decrease) 2013 2012 2013 vs. 2012 2013 2012 2013 vs. 2012 Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount ($ in millions) Fixed maturities 4.7 %$ 569.2 5.1 %$ 617.5 (0.4 )%$ (48.3 ) 4.8 %$ 1,159.7 5.2 %$ 1,258.5 (0.4 )%$ (98.8 ) Equity securities 0.4 0.8 2.5 3.3 (2.1 ) (2.5 ) 3.1 9.0 4.0 8.4 (0.9 ) 0.6 Mortgage loans - commercial 5.1 133.6 5.7 140.5 (0.6 ) (6.9 ) 5.1 269.7 5.8 279.7 (0.7 ) (10.0 ) Mortgage loans - residential 4.3 14.1 5.4 18.1 (1.1 ) (4.0 ) 4.5 29.3 6.0 40.1 (1.5 ) (10.8 ) Real estate 4.9 15.0 4.8 13.6 0.1 1.4 4.8 29.0 4.3 24.6 0.5 4.4 Policy loans 5.8 12.5 6.2 13.6 (0.4 ) (1.1 ) 5.8 24.9 6.3 27.6 (0.5 ) (2.7 ) Cash and cash equivalents 0.7 2.3 0.5 2.1 0.2 0.2 0.8 10.0 0.4 4.3 0.4 5.7 Other investments 2.8 21.4 1.7 12.8 1.1 8.6 2.9 45.4 1.6 24.2 1.3 21.2 Total before investment expenses 4.5 768.9 4.9 821.5 (0.4 ) (52.6 ) 4.6 1,577.0 5.0 1,667.4 (0.4 ) (90.4 ) Investment expenses (0.1 ) (19.2 ) (0.1 ) (20.5 ) - 1.3 (0.1 ) (38.0 ) (0.1 ) (41.6 ) - 3.6 Net investment income 4.4 %$ 749.7 4.8 %$ 801.0 (0.4 )%$ (51.3 ) 4.5 %$ 1,539.0 4.9 %$ 1,625.8 (0.4 )%$ (86.8 )
Three Months Ended
Net investment income decreased primarily due to lower investment yields in our U.S. operations and lower inflation-based investments returns on average invested assets and cash as a result of lower inflation in
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Six Months Ended
Net investment income decreased primarily due to lower investment yields in our U.S. operations and lower inflation-based investments returns on average invested assets and cash as a result of lower inflation in
Net Realized Capital Gains (Losses)
The following table presents the contributors to net realized capital gains and losses for our invested assets for the periods indicated.
For the three months ended Increase For the six months ended Increase June 30, (decrease) June 30, (decrease) 2013 2012 2013 vs. 2012 2013 2012 2013 vs. 2012 (in millions) Fixed maturities, available-for-sale - credit impairments (1)$ (26.6 ) $ (32.0 ) $ 5.4$ (49.2 ) $ (60.8 ) $ 11.6 Fixed maturities, available-for-sale - other 1.1 2.7 (1.6 ) 8.7 15.6 (6.9 ) Fixed maturities, trading (6.3 ) (2.0 ) (4.3 ) (6.2 ) 1.0 (7.2 ) Equity securities - credit impairments (0.1 ) - (0.1 ) (0.1 ) - (0.1 ) Derivatives and related hedge activities (2) (51.4 ) 48.2 (99.6 ) (63.6 ) 44.7 (108.3 ) Commercial mortgages (6.5 ) (3.4 ) (3.1 ) (5.7 ) (7.9 ) 2.2 Other gains (losses) 9.7 (13.3 ) 23.0 (14.9 ) 0.9 (15.8 ) Net realized capital gains (losses)$ (80.1 ) $ 0.2 $ (80.3 )$ (131.0 ) $ (6.5 ) $ (124.5 )
-------------------------------------------------------------------------------- (1) Includes credit impairments as well as losses on sales
of
fixed maturities to reduce credit risk, net of realized credit recoveries on the sale of previously impaired securities. Credit gains on sales, excluding associated foreign currency fluctuations that are included in derivatives and related hedging activities, were a net gain of$2.1 million and$0.0 million for the six months endedJune 30, 2013 and 2012, respectively. There were no credit gains on sales for the three months endedJune 30, 2013 and 2012. (2) Includes fixed maturities, available-for-sale impairment-related net gains of$0.2 million and$0.0 for the six months endedJune 30, 2013 and 2012, respectively, which were hedged by derivatives reflected in this line. There were no fixed maturities available-for-sale impairment-related net gains in this line for the three months endedJune 30, 2013 and 2012.
Three Months Ended
Net realized capital losses on fixed maturities, available-for-sale - credit impairments decreased primarily due to lower impairments on commercial mortgage-backed and other asset-backed securities as a result of improved market conditions. Net realized capital losses on derivatives and related hedge activities increased due to losses versus gains on the GMWB embedded derivatives, including losses versus gains from changes in the spread reflecting our own creditworthiness, and related hedging instruments, and due to losses versus gains on derivatives not designated as hedging instruments including interest rate swaps due to changes in interest rates.
Other net realized capital gains increased due to gains on the sale of real estate.
Six Months Ended
Net realized capital losses on fixed maturities, available-for-sale - credit impairments decreased primarily due to lower impairments on commercial mortgage-backed and other asset-backed securities as a result of improved market conditions. Net realized capital losses on derivatives and related hedge activities increased due to losses versus gains on the GMWB embedded derivatives, including losses versus gains from changes in the spread reflecting our own creditworthiness, and related hedging instruments, and due to losses versus gains on derivatives not designated as hedging instruments including interest rate swaps and currency forwards due to changes in interest and exchange rates. Other net realized capital losses increased due to foreign currency translation on cash held for the Cuprum acquisition that was completed in the first quarter 2013 and a write-off of impaired corporate owned real estate. Losses were partially offset by an 109
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increase in realized gains on the sale of real estate.
U.S. Investment Operations Of our invested assets,$61,718.4 million were held by our U.S. operations as ofJune 30, 2013 . Our U.S. invested assets are managed primarily by ourPrincipal Global Investors segment. Our primary investment objective is to maximize after-tax returns consistent with acceptable risk parameters. We seek to protect policyholders' benefits by optimizing the risk/return relationship on an ongoing basis, through asset/liability matching, reducing the credit risk, avoiding high levels of investments that may be redeemed by the issuer, maintaining sufficiently liquid investments and avoiding undue asset concentrations through diversification. We are exposed to two primary sources of investment risk:
† credit risk, relating to the uncertainty associated with the continued ability of an obligor to make timely payments of principal and interest and
† interest rate risk, relating to the market price and/or cash flow variability associated with changes in market yield curves.
Our ability to manage credit risk is essential to our business and our profitability. We devote considerable resources to the credit analysis of each new investment. We manage credit risk through industry, issuer and asset class diversification. Our Investment Committee, appointed by our Board of Directors, is responsible for establishing all investment policies and approving or authorizing all investments, except the Executive Committee of the Board must approve any investment transaction exceeding$500.0 million . As ofJune 30, 2013 , there are thirteen members on the Investment Committee, one of whom is a member of our Board of Directors. The remaining members are senior management members representing various areas of our company.
We also seek to manage call or prepayment risk arising from changes in interest rates. We assess and price for call or prepayment risks in all of our investments and monitor these risks in accordance with asset/liability management policies.
The amortized cost and weighted average yield, calculated using amortized cost, of non-structured fixed maturity securities that will be callable at the option of the issuer, excluding securities with a make-whole provision, was$791.9 million and 4.8%, respectively, as ofJune 30, 2013 . In addition, the amortized cost and weighted average yield of residential mortgage-backed pass-through securities, residential collateralized mortgage obligations, and asset-backed securities - home equity with material prepayment risk was$4,251.5 million and 3.6%, respectively, as ofJune 30, 2013 . Our Fixed Income Securities Committee, consisting of fixed income securities senior management members, approves the credit rating for the fixed maturities we purchase. Teams of security analysts, organized by industry, analyze and monitor these investments. In addition, we have teams who specialize in RMBS, CMBS, ABS, municipals and below investment grade securities. Our analysts monitor issuers held in the portfolio on a continuous basis with a formal review documented annually or more frequently if material events affect the issuer. The analysis includes both fundamental and technical factors. The fundamental analysis encompasses both quantitative and qualitative analysis of the issuer. The qualitative analysis includes an assessment of both accounting and management aggressiveness of the issuer. In addition, technical indicators such as stock price volatility and credit default swap levels are monitored. Our Fixed Income Securities Committee also reviews private transactions on a continuous basis to assess the quality ratings of our privately placed investments. We regularly review our investments to determine whether we should re-rate them, employing the following criteria: † material changes in the issuer's revenues or margins; † significant management or organizational changes; † significant changes regarding the issuer's industry;
† debt service coverage or cash flow ratios that fall below industry-specific thresholds;
† violation of financial covenants and † other business factors that relate to the issuer. A dedicated risk management team is responsible for centralized monitoring of the commercial mortgage loan portfolio. We apply a variety of strategies to minimize credit risk in our commercial mortgage loan portfolio. When considering new commercial mortgage loans, we review the cash flow fundamentals of the property, make a physical assessment of the underlying security, conduct a comprehensive market analysis and compare against industry lending practices. We use a proprietary risk rating model to evaluate all new and substantially all existing loans within the portfolio. The proprietary risk model is designed to stress projected cash flows under simulated economic and market downturns. Our lending guidelines are typically 75% or less loan-to-value ratio and a debt service coverage ratio of at least 1.2 times. We analyze investments outside of these guidelines based on cash flow quality, tenancy and other factors. The following table presents loan-to-value and debt service coverage ratios for our brick and mortar commercial mortgages, excludingPrincipal Global Investors segment mortgages: 110
-------------------------------------------------------------------------------- Table of Contents Weighted average loan-to-value ratio Debt service coverage ratio June 30, 2013 December 31, 2012 June 30, 2013 December 31, 2012 New mortgages 50 % 48 % 2.8x 3.2x Entire mortgage portfolio 52 % 54 % 2.4x 2.2x Our investment decisions and objectives are a function of the underlying risks and product profiles of each primary business operation. In addition, we diversify our product portfolio offerings to include products that contain features that will protect us against fluctuations in interest rates. Those features include adjustable crediting rates, policy surrender charges and market value adjustments on liquidations. For further information on our management of interest rate risk, see Item 3. "Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk."
Overall Composition of U.S. Invested Assets
As shown in the following table, the major categories of U.S. invested assets are fixed maturities and commercial mortgage loans. The remainder is invested in other investments, real estate, residential mortgage loans and equity securities. In addition, policy loans are included in our invested assets. The following discussion analyzes the composition of U.S. invested assets, but excludes invested assets of the separate accounts. June 30, 2013 December 31, 2012 Carrying amount % of total Carrying amount % of total ($ in millions) Fixed maturities: Public$ 31,195.0 50 %$ 32,437.5 52 % Private 15,167.8 25 15,429.8 25 Equity securities 267.4 - 263.2 - Mortgage loans: Commercial 10,849.0 18 10,167.7 16 Residential 587.8 1 657.7 1 Real estate held for sale 127.3 - 80.0 - Real estate held for investment 1,131.2 2 1,092.5 2 Policy loans 839.8 1 838.2 1 Other investments 1,553.1 3 1,847.4 3 Total invested assets 61,718.4 100 % 62,814.0 100 % Cash and cash equivalents 983.6 4,071.8 Total invested assets and cash$ 62,702.0 $ 66,885.8 Fixed Maturities Fixed maturities consist of publicly traded and privately placed bonds, ABS, redeemable preferred stock and certain nonredeemable preferred stock. Included in the privately placed category as ofJune 30, 2013 andDecember 31, 2012 , were$10.0 billion and$9.9 billion , respectively, of securities subject to certain holding periods and resale restrictions pursuant to Rule 144A of the Securities Act of 1933. 111
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Fixed maturities were diversified by category of issuer, as shown in the following table for the periods indicated.
June 30, 2013 December 31, 2012 Carrying amount % of total Carrying
amount % of total
($ in millions) U.S. government and agencies $ 792.4 2 % $ 953.7 2 % States and political subdivisions 3,569.6 8 3,327.8 7 Non-U.S. governments 543.6 1 663.4 1 Corporate - public 17,644.7 38 18,718.2 39 Corporate - private 12,547.8 27 12,808.6 27
Residential
mortgage-backed
pass-through securities 2,976.0 6 3,277.4 7 Commercial mortgage-backed securities 3,955.3 9 3,900.2 8 Residential collateralized mortgage obligations 1,015.1 2 1,115.3 2 Asset-backed securities 3,318.3 7 3,102.7 7 Total fixed maturities$ 46,362.8 100 %$ 47,867.3 100 %
We believe it is desirable to hold residential mortgage-backed pass-through securities due to their credit quality and liquidity as well as portfolio diversification characteristics. Our portfolio is comprised of
CMBS provide varying levels of credit protection, diversification and reduced event risk depending on the securities owned and composition of the loan pool. CMBS are predominantly comprised of large pool securitizations that are diverse by property type, borrower and geographic dispersion. The risks to any CMBS deal are determined by the credit quality of the underlying loans and how those loans perform over time. Another key risk is the vintage of the underlying loans and the state of the markets during a particular vintage. In the CMBS market, there is a material difference in the outlook for the performance of loans originated in 2004 and earlier relative to loans originated in 2005 through 2008. For loans originated prior to 2005, underwriting assumptions were more conservative regarding required debt service coverage and loan-to-value ratios. For the 2005 through 2008 vintages, real estate values peaked and the underwriting expectations were that values would continue to increase, which makes those loan values more sensitive to market declines. The 2009 through 2013 vintages represent a return to debt service coverage ratios and loan-to-value ratios that more closely resemble loans originated prior to 2005. We purchase ABS to diversify the overall credit risks of the fixed maturities portfolio and to provide attractive returns. The principal risks in holding ABS are structural and credit risks. Structural risks include the security's priority in the issuer's capital structure, the adequacy of and ability to realize proceeds from the collateral and the potential for prepayments. Credit risks involve collateral and issuer/servicer risk where collateral and servicer performance may deteriorate. Our ABS portfolio is diversified both by type of asset and by issuer. We actively monitor holdings of ABS to recognize adverse changes in the risk profile of each security. Prepayments in the ABS portfolio are, in general, insensitive to changes in interest rates or are insulated from such changes by call protection features. In the event that we are subject to prepayment risk, we monitor the factors that impact the level of prepayment and prepayment speed for those ABS. In addition, we diversify the risks of ABS by holding a diverse class of securities, which limits our exposure to any one security. The international exposure held in our U.S. operation's fixed maturities portfolio was 27% of total fixed maturities as ofJune 30, 2013 , and 27% as ofDecember 31, 2012 . It is comprised of corporate and foreign government fixed maturities. The following table presents the carrying amount of our international exposure for our U.S. operation's fixed maturities portfolio for the periods indicated. June 30, 2013 December 31, 2012 (in millions) European Union$ 4,193.0 $ 4,415.8 United Kingdom 2,644.7 2,663.6 Asia-Pacific 1,416.7 1,369.0 Australia/New Zealand 1,367.3 1,383.8 Latin America 823.7 844.2 Other countries (1) 1,877.9 2,047.6 Total$ 12,323.3 $ 12,724.0
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(1) Includes exposure from 13 countries as of
International fixed maturities are determined by the country of domicile of the parent entity of an individual asset. All
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international fixed maturities held by our U.S. operations are either denominated in U.S. dollars or have been swapped into U.S. dollar equivalents. Our international investments are analyzed internally by country and industry credit investment professionals. We control concentrations using issuer and country level exposure benchmarks, which are based on the credit quality of the issuer and the country. Our investment policy limits total international fixed maturities investments and we are within those internal limits. Exposure toCanada is not included in our international exposure. As ofJune 30, 2013 andDecember 31, 2012 , our investments inCanada totaled$1,599.3 million and$1,819.0 million , respectively. Economic and fiscal conditions in select European countries, includingGreece ,Ireland ,Italy ,Portugal and Spain, continue to cause credit concerns particularly to financial institutions and banks with exposure to the European periphery region. Our exposure to the region within our U.S. investment operations fixed maturities portfolio is modest and manageable, representing 2.1% and 2.2% of total fixed maturities as ofJune 30, 2013 andDecember 31, 2012 , respectively. Additionally, we did not hold any sovereign debt issuances of the selected countries and had not bought or sold credit protection on sovereign issuances as ofJune 30, 2013 andDecember 31, 2012 . The fixed maturities within our U.S. operations portfolio with exposure to the region are primarily corporate credit issuances of large multinational companies where the majority of revenues are coming from outside the country where the parent company is domiciled. Our experience indicates multinational companies have demonstrated better market price performance and credit ratings stability. As ofJune 30, 2013 , 95% of our total portfolio exposure consists of investment grade bonds with an average price of 103 (carrying value/amortized cost) and a weighted average time to maturity of 5 years.
The following table presents the carrying amount of our European periphery zone fixed maturities exposure for the periods indicated:
June 30, 2013 Select European Exposure Greece Ireland Italy Portugal Spain Total (in millions) Non-Sovereign: Financial institutions $ -$ 58.4 $ 44.1 $ -$ 126.0 $ 228.5 Non-financial institutions - 292.8 216.8 19.9 238.1 767.6 Total $ -$ 351.2 $ 260.9 $ 19.9 $ 364.1 $ 996.1 December 31, 2012 Select European Exposure Greece Ireland Italy Portugal Spain Total (in millions) Non-Sovereign: Financial institutions $ -$ 59.9 $ 44.4 $ -$ 138.5 $ 242.8 Non-financial institutions - 270.5 225.7 26.7 278.1 801.0 Total $ -$ 330.4 $ 270.1 $ 26.7 $ 416.6 $ 1,043.8 For further details on our International investment operations exposure to these European countries, see "International Investment Operations - Fixed Maturities Exposure." 113
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Fixed Maturities Credit Concentrations. One aspect of managing credit risk is through industry, issuer and asset class diversification. Our credit concentrations are managed to established limits. The following table presents our top ten exposures as ofJune 30, 2013 . Amortized cost (in millions) General Electric Co. $ 207.1 AT&T Inc. 196.8 Berkshire Hathaway Inc. 165.3 Duke Energy Corp. 157.6 JPMorgan Chase & Co. 149.3 Merck & Co Inc. 146.6 Prudential Financial Inc. 144.9 Wells Fargo & Co. 143.8 Republic of Korea 142.7 HSBC Holdings PLC 138.2 Total top ten exposures$ 1,592.3 Fixed Maturities Valuation and Credit Quality. Valuation techniques for the fixed maturities portfolio vary by security type and the availability of market data. The use of different pricing techniques and their assumptions could produce different financial results. See Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 10, Fair Value Measurements" for further details regarding our pricing methodology. Once prices are determined, they are reviewed by pricing analysts for reasonableness based on asset class and observable market data. Investment analysts who are familiar with specific securities review prices for reasonableness through direct interaction with external sources, review of recent trade activity or use of internal models. All fixed maturities placed on the "watch list" are periodically analyzed by investment analysts or analysts that focus on troubled securities ("Workout Group "). This group then meets with the Chief Investment Officer and the Portfolio Managers to determine reasonableness of prices. The valuation of impaired bonds for which there is no quoted price is typically based on the present value of the future cash flows expected to be received. Although we believe these values reasonably reflect the fair value of those securities, the key assumptions about risk premiums, performance of underlying collateral (if any) and other market factors involve qualitative and unobservable inputs. The Securities Valuation Office ("SVO") of the NAIC monitors the bond investments of insurers for regulatory capital and reporting purposes and, when required, assigns securities to one of six investment categories. For certain bonds, the NAIC designations closely mirror the Nationally Recognized Statistical Rating Organizations' ("NRSRO") credit ratings. For most corporate bonds, NAIC designations 1 and 2 include bonds considered investment grade by such rating organizations. Bonds are considered investment grade when rated ''Baa3'' or higher by Moody's, or ''BBB-'' or higher by S&P. NAIC designations 3 through 6 are referred to as below investment grade. Bonds are considered below investment grade when rated ''Ba1'' or lower by Moody's, or ''BB+'' or lower by S&P. However, for loan-backed and structured securities, as defined by the NAIC, the NAIC rating is not always equivalent to an NRSRO rating as described below. For non-agency RMBS,PIMCO Advisors models and assigns the NAIC ratings. For CMBS, Blackrock Solutions undertakes the modeling and assignment of those NAIC ratings. Other loan-backed and structured securities may be subject to an intrinsic price matrix as provided by the NAIC. This may result in a final designation being higher or lower than the NRSRO credit rating. The following table presents our total fixed maturities by NAIC designation and the equivalent ratings of the NRSROs as of the periods indicated as well as the percentage, based on fair value, that each designation comprises. June 30, 2013 December 31, 2012 % of total % of total NAIC Amortized Carrying carrying Carrying carrying Rating Rating Agency Equivalent cost amount amount Amortized cost amount amount ($ in millions) 1 AAA/AA/A$ 27,235.1 $ 28,428.5 61 %$ 26,880.3 $ 28,943.8 60 % 2 BBB 13,909.3 14,676.6 32 14,331.8 15,596.0 33 3 BB 2,392.7 2,284.7 5 2,416.0 2,330.1 5 4 B 556.3 519.0 1 677.2 615.7 1 5 CCC and lower 405.6 318.7 1 335.9 254.7 1 6 In or near default 214.5 135.3 - 259.2 127.0 - Total fixed maturities$ 44,713.5 $ 46,362.8 100 %$ 44,900.4 $ 47,867.3 100 % 114
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Fixed maturities include 27 securities with an amortized cost of$335.8 million , gross gains of$2.9 million , gross losses of$7.0 million and a carrying amount of$331.7 million as ofJune 30, 2013 , that are still pending a review and assignment of a rating by the SVO. Due to the timing of when fixed maturities are purchased, legal documents are filed and the review by the SVO is completed, there will always be securities in our portfolio that are unrated over a reporting period. In these instances, an equivalent rating is assigned based on our fixed income analyst's assessment.Commercial Mortgage-Backed Securities andHome Equity Asset-Backed Securities Portfolios. As ofJune 30, 2013 , based on amortized cost, 52% of our CMBS portfolio had ratings of A or higher and 34% was issued prior to 2005 and after 2008 and 6% of our ABS home equity portfolio had ratings of A or higher and 65% was issued prior to 2005. The following tables present our exposure by credit quality, based on the lowest NRSRO designation, and year of issuance ("vintage") for our CMBS portfolio as of the periods indicated. June 30, 2013 AAA AA A BBB BB+ and Below Total Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying cost amount cost amount cost
amount cost amount cost amount cost amount
(in millions) 2003 & Prior$ 22.5 $ 23.0 $ 0.9 $ 0.8 $ 3.9 $ 4.0 $ 43.3 $ 47.7 $ 95.8 $ 89.2 $ 166.4 $ 164.7 2004 47.3 48.3 61.5 63.5
44.4 46.1 33.3 34.3 82.1 68.7
268.6 260.9 2005 333.4 352.7 52.1 55.6
39.4 38.6 108.0 109.2 202.6 150.3
735.5 706.4 2006 92.7 97.9 46.0 47.1
72.7 77.2 108.2 114.0 144.7 106.6
464.3 442.8 2007 87.7 90.2 61.7 69.1
156.2 173.7 235.9 256.2 805.0 650.5 1,346.5 1,239.7 2008
11.1 11.5 43.5 49.8 - - 18.5 19.3 67.7 75.8 140.8 156.4 2009 82.1 87.7 96.2 101.4 - - - - - - 178.3 189.1 2010 64.1 70.6 61.7 63.5 - - - - - - 125.8 134.1 2011 105.8 105.8 118.4 119.4 - - - - - - 224.2 225.2 2012 214.6 213.8 151.4 151.8 - - - - - - 366.0 365.6 2013 55.4 53.0 17.8 17.4 - - - - - - 73.2 70.4 Total (1)$ 1,116.7 $ 1,154.5$ 711.2 $ 739.4 $ 316.6 $ 339.6 $ 547.2 $ 580.7 $ 1,397.9 $ 1,141.1 $ 4,089.6 $ 3,955.3
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(1) The CMBS portfolio included agency CMBS with a
December 31, 2012 AAA AA A BBB BB+ and Below Total Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying cost amount cost amount cost amount cost amount cost amount cost amount (in millions) 2003 & Prior$ 40.8 $ 41.7 $ 24.1 $ 24.3 $ 37.7 $ 38.2 $ 60.5 $ 61.4 $ 118.2 $ 98.2 $ 281.3 $ 263.8 2004 73.2 76.3 56.9 59.5 49.2 48.1 31.2 26.5 97.0 71.5 307.5 281.9 2005 345.0 373.2 47.3 51.7 39.6 39.1 91.7 88.8 211.7 140.0 735.3 692.8 2006 124.2 132.1 30.7 32.4 72.9 79.2 93.7 101.8 160.8 110.6 482.3 456.1 2007 117.1 118.4 59.5 69.9 158.6 181.2 231.7 261.6 758.4 544.8 1,325.3 1,175.9 2008 11.2 12.2 43.5 52.3 - - 23.4 26.0 31.5 32.6 109.6 123.1 2009 92.3 101.2 100.5 108.1 - - - - - - 192.8 209.3 2010 64.1 73.1 65.1 68.9 - - - - - - 129.2 142.0 2011 97.5 100.6 122.2 128.3 - - - - - - 219.7 228.9 2012 157.7 163.2 156.9 163.2 - - - - - - 314.6 326.4 Total (1)$ 1,123.1 $ 1,192.0 $ 706.7 $ 758.6 $ 358.0 $ 385.8 $ 532.2 $ 566.1 $ 1,377.6 $ 997.7 $ 4,097.6 $ 3,900.2
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(1) The CMBS portfolio included agency CMBS with a
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The following tables present our exposure by credit quality, based on the lowest NRSRO designation, and vintage for our ABS home equity portfolio supported by subprime first lien mortgages as of the periods indicated. June 30, 2013 AAA AA A BBB BB+ and Below Total Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying cost amount cost amount cost
amount cost amount cost amount cost amount (in millions) 2003 & Prior$ 1.2 $ 1.2 $ 4.7 $ 4.7 $ 6.5 $ 6.6 $ 19.8 $ 20.2 $ 134.3 $ 125.5 $ 166.5 $ 158.2 2004 - - - - 5.9 5.8 18.5 18.8 44.1 42.5 68.5 67.1 2005 - - - - 3.0 3.1 - - 71.2 66.4 74.2 69.5 2006 - - - - - - - - 13.3 13.4 13.3 13.4 2007 - - - - - - - - 37.5 34.3 37.5 34.3 Total$ 1.2 $ 1.2 $ 4.7 $ 4.7 $ 15.4 $ 15.5 $ 38.3 $ 39.0 $ 300.4 $ 282.1 $ 360.0 $ 342.5 December 31, 2012 AAA AA A BBB BB+ and Below Total Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying Amortized Carrying cost amount cost amount cost
amount cost amount cost amount cost amount (in millions) 2003 & Prior$ 2.0 $ 2.0 $ 4.8 $ 5.0 $ 5.7 $ 5.8 $ 21.6 $ 21.5 $ 141.4 $ 127.8 $ 175.5 $ 162.1 2004 - - - - 5.9 5.7 19.4 19.2 44.9 40.2 70.2 65.1 2005 - - - - 3.0 3.1 - - 71.4 58.0 74.4 61.1 2006 - - - - - - - - 13.8 12.6 13.8 12.6 2007 - - - - - - - - 37.2 32.9 37.2 32.9 Total$ 2.0 $ 2.0 $ 4.8 $ 5.0 $ 14.6 $ 14.6 $ 41.0 $ 40.7 $ 308.7 $ 271.5 $ 371.1 $ 333.8 Fixed Maturities Watch List. We monitor any decline in the credit quality of fixed maturities through the designation of "problem securities," "potential problem securities" and "restructured securities". We define problem securities in our fixed maturity portfolio as securities: (i) as to which principal and/or interest payments are in default or where default is perceived to be imminent in the near term, or (ii) issued by a company that went into bankruptcy subsequent to the acquisition of such securities. We define potential problem securities in our fixed maturity portfolio as securities included on an internal "watch list" for which management has concerns as to the ability of the issuer to comply with the present debt payment terms and which may result in the security becoming a problem or being restructured. The decision whether to classify a performing fixed maturity security as a potential problem involves significant subjective judgments by our management as to the likely future industry conditions and developments with respect to the issuer. We define restructured securities in our fixed maturity portfolio as securities where a concession has been granted to the borrower related to the borrower's financial difficulties that would not have otherwise been considered. We determine that restructures should occur in those instances where greater economic value will be realized under the new terms than through liquidation or other disposition and may involve a change in contractual cash flows. If the present value of the restructured cash flows is less than the current cost of the asset being restructured, a realized capital loss is recorded in net income and a new cost basis is established.
The following table presents the total carrying amount of our fixed maturities portfolio, as well as its problem, potential problem and restructured fixed maturities for the periods indicated.
June 30, 2013 December 31, 2012 ($ in millions)
Total fixed maturities (public and private)
47,867.3
Problem fixed maturities (1) $ 436.9 $
385.8
Potential problem fixed maturities 169.7
204.6
Restructured problem fixed maturities - 15.2 Total problem, potential problem and restructured fixed maturities $ 606.6 $
605.6
Total problem, potential problem and restructured fixed maturities as a percent of total fixed maturities 1.31 % 1.27 %
-------------------------------------------------------------------------------- (1) The problem fixed maturities carrying amount is net of
other-than-temporary impairment losses.
Fixed Maturities Impairments. We have a process in place to identify securities that could potentially have a credit impairment that is other than temporary. This process involves monitoring market events that could impact issuers' credit ratings, business climate, management changes, litigation and government actions and other similar factors. This process also involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. 116
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Each reporting period, a group of individuals including the Chief Investment Officer, our Portfolio Managers, members of ourWorkout Group and representatives from Investment Accounting review all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. The analysis focuses on each issuer's ability to service its debts in a timely fashion. Formal documentation of the analysis and our decision is prepared and approved by management. We consider relevant facts and circumstances in evaluating whether a credit or interest-rate related impairment of a security is other than temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events; (4) for structured securities, the adequacy of the expected cash flows and (5) our intent to sell the security or whether it is more likely than not we will be required to sell the security before recovery of its amortized cost which, in some cases, may extend to maturity. To the extent we determine that a security is deemed to be other than temporarily impaired, an impairment loss is recognized. For additional details, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 4, Investments." We would not consider a security with unrealized losses to be other than temporarily impaired when it is not our intent to sell the security, it is not more likely than not that we would be required to sell the security before recovery of the amortized cost, which may be maturity, and we expect to recover the amortized cost basis. However, we do sell securities under certain circumstances, such as when we have evidence of a change in the issuer's creditworthiness, when we anticipate poor relative future performance of securities, when a change in regulatory requirements modifies what constitutes a permissible investment or the maximum level of investments held or when there is an increase in capital requirements or a change in risk weights of debt securities. Sales generate both gains and losses. There are a number of significant risks and uncertainties inherent in the process of monitoring credit impairments and determining if an impairment is other than temporary. These risks and uncertainties include: (1) the risk that our assessment of an issuer's ability to meet all of its contractual obligations will change based on changes in the credit characteristics of that issuer, (2) the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, (3) the risk that our investment professionals are making decisions based on fraudulent or misstated information in the financial statements provided by issuers and (4) the risk that new information obtained by us or changes in other facts and circumstances lead us to change our intent to not sell the security prior to recovery of its amortized cost. Any of these situations could result in a charge to net income in a future period. The net realized loss relating to other-than-temporary credit impairments and credit related sales of fixed maturities was$47.2 million and$60.8 million for the six months endedJune 30, 2013 and 2012, respectively. 117 --------------------------------------------------------------------------------
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Fixed Maturities Available-for-Sale
The following tables present our fixed maturities available-for-sale by industry category and the associated gross unrealized gains and losses, including other-than-temporary impairment losses reported in AOCI, as of the periods indicated. June 30, 2013 Gross Gross Carrying Amortized cost unrealized gains unrealized losses amount (in millions) Finance - Banking$ 4,284.0 $ 153.2 $ 198.6$ 4,238.6 Finance - Brokerage 297.7 18.3 1.2 314.8 Finance - Finance Companies 159.2 8.9 0.4 167.7 Finance - Financial Other 487.8 65.4 0.8 552.4 Finance - Insurance 2,614.4 204.4 11.9 2,806.9 Finance - REITS 901.6 48.5 6.1 944.0 Industrial - Basic Industry 1,612.2 82.2 18.8 1,675.6 Industrial - Capital Goods 1,812.0 125.6 3.9 1,933.7 Industrial - Communications 2,135.5 157.0 12.6 2,279.9 Industrial - Consumer Cyclical 1,562.2 114.1 9.5 1,666.8 Industrial - Consumer Non-Cyclical 3,197.8 218.0 17.0 3,398.8 Industrial - Energy 2,009.8 169.3 11.7 2,167.4 Industrial - Other 400.8 23.7 0.5 424.0 Industrial - Technology 925.7 48.6 4.3 970.0 Industrial - Transportation 750.9 49.2 6.8 793.3 Utility - Electric 2,790.5 211.9 32.6 2,969.8 Utility - Natural Gas 1,075.5 91.0 11.0 1,155.5 Utility - Other 280.0 20.7 1.3 299.4 Government guaranteed 1,215.3 115.1 6.9 1,323.5 Total corporate securities 28,512.9 1,925.1 355.9 30,082.1 Residential mortgage-backed pass-through securities 2,827.1 116.6 28.5 2,915.2 Commercial mortgage-backed securities 4,087.6 191.9 326.2 3,953.3 Residential collateralized mortgage obligations 1,003.6 22.5 11.0 1,015.1 Asset-backed securities - Home equity (1) 360.0 9.5 27.0 342.5 Asset-backed securities - All other 2,551.2 20.2 13.0 2,558.4 Collateralized debt obligations - Credit 54.4 - 31.2 23.2 Collateralized debt obligations - CMBS 49.7 3.0 5.1 47.6 Collateralized debt obligations - Loans 279.5 5.6 0.5 284.6 Total mortgage-backed and other asset-backed securities 11,213.1 369.3 442.5 11,139.9 U.S. government and agencies 800.8 18.4 26.8 792.4 States and political subdivisions 3,349.0 138.6 59.4 3,428.2 Non-U.S. governments 461.1 83.8 1.3 543.6 Total fixed maturities, available-for-sale$ 44,336.9 $ 2,535.2 $ 885.9$ 45,986.2
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(1) This exposure is all related to sub-prime mortgage loans. 118
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Table of Contents December 31, 2012 Gross Gross Amortized unrealized unrealized Carrying cost gains losses amount (in millions) Finance - Banking$ 4,243.6 $ 219.9 $ 234.1 $ 4,229.4 Finance - Brokerage 377.2 31.0 1.1 407.1 Finance - Finance Companies 173.7 12.2 - 185.9 Finance - Financial Other 519.5 79.9 - 599.4 Finance - Insurance 2,748.2 280.2 11.0 3,017.4 Finance - REITS 982.8 66.3 4.1 1,045.0 Industrial - Basic Industry 1,589.0 149.7 1.0 1,737.7 Industrial - Capital Goods 2,012.7 188.1 0.6 2,200.2 Industrial - Communications 2,025.7 242.2 1.9 2,266.0 Industrial - Consumer Cyclical 1,551.0 174.1 2.9 1,722.2 Industrial - Consumer Non-Cyclical 3,303.0 332.5 1.4 3,634.1 Industrial - Energy 1,985.7 296.9 1.6 2,281.0 Industrial - Other 477.8 38.2 - 516.0 Industrial - Technology 904.8 66.4 0.4 970.8 Industrial - Transportation 730.2 64.4 0.7 793.9 Utility - Electric 2,739.5 310.6 12.1 3,038.0 Utility - Natural Gas 1,033.7 136.4 0.9 1,169.2 Utility - Other 291.1 34.1 - 325.2 Government guaranteed 1,126.7 152.8 1.6 1,277.9 Total corporate securities 28,815.9 2,875.9 275.4 31,416.4 Residential mortgage-backed pass-through securities 2,997.8 202.3 0.4 3,199.7 Commercial mortgage-backed securities 4,094.8 241.7 439.1 3,897.4 Residential collateralized mortgage obligations 1,091.9 31.2 8.9 1,114.2 Asset-backed securities - Home equity (1) 371.1 4.7 42.0 333.8 Asset-backed securities - All other 2,293.9 37.6 0.3 2,331.2 Collateralized debt obligations - Credit 79.3 - 40.0 39.3 Collateralized debt obligations - CMBS 92.2 3.4 15.1 80.5 Collateralized debt obligations - Loans 242.3 3.6 1.1 244.8 Collateralized debt obligations - ABS 15.0 - 0.4 14.6 Total mortgage-backed and other asset-backed securities 11,278.3 524.5 547.3 11,255.5 U.S. government and agencies 911.4 33.2 0.3 944.3 States and political subdivisions 2,940.4 241.1 2.7 3,178.8 Non-U.S. governments 545.5 117.9 - 663.4 Total fixed maturities, available-for-sale$ 44,491.5 $ 3,792.6 $ 825.7 $ 47,458.4
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(1) This exposure is all related to sub-prime mortgage loans. Of the$885.9 million in gross unrealized losses as ofJune 30, 2013 , there were$0.3 million in losses attributed to securities scheduled to mature in one year or less,$49.9 million attributed to securities scheduled to mature between one to five years,$80.2 million attributed to securities scheduled to mature between five to ten years,$313.0 million attributed to securities scheduled to mature after ten years and$442.5 million related to mortgage-backed and other ABS that are not classified by maturity year. As ofJune 30, 2013 , we were in a$1,649.3 million net unrealized gain position as compared to a$2,966.9 million net unrealized gain position as ofDecember 31, 2012 . The$1,317.6 million decrease in net unrealized gains for the six months endedJune 30, 2013 , can primarily be attributed to an approximate 48 basis points increase in interest rates. Fixed Maturities Available-for-Sale Unrealized Losses. We believe that our long-term fixed maturities portfolio is well diversified among industry types and between publicly traded and privately placed securities. Each year, we direct the majority of our net cash inflows into investment grade fixed maturities. Our current policy is to limit the percentage of cash flow invested in below investment grade assets to 10% of cash flow. We invest in privately placed fixed maturities to enhance the overall value of the portfolio, increase diversification and obtain higher yields than are possible with comparable quality public market securities. Generally, private placements provide broader access to 119 --------------------------------------------------------------------------------
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management information, strengthened negotiated protective covenants, call protection features and, where applicable, a higher level of collateral. They are, however, generally not freely tradable because of restrictions imposed by federal and state securities laws and illiquid trading markets. The following table presents our fixed maturities available-for-sale by investment grade and below investment grade and the associated gross unrealized gains and losses, including the other-than-temporary impairment losses reported in OCI, as of the periods indicated. June 30, 2013 December 31, 2012 Gross Gross Gross Gross Amortized unrealized unrealized Carrying Amortized unrealized unrealized Carrying cost gains losses amount cost gains losses amount (in millions) Investment grade: Public$ 28,034.7 $ 1,725.1 $ 324.3 $
29,435.5
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The following tables present the carrying amount and the gross unrealized losses, including other-than-temporary impairment losses reported in OCI, on below investment grade fixed maturities available-for-sale by aging category as of the periods indicated. June 30, 2013 Public Private Total Gross Gross Gross Carrying unrealized Carrying unrealized Carrying unrealized amount losses amount losses amount losses (in millions) Three months or less$ 317.1 $ 6.3 $ 366.2 $ 9.6 $ 683.3 $ 15.9 Greater than three to six months 0.1 - 20.1 1.1 20.2 1.1 Greater than six to nine months 7.3 0.2 12.5 0.3 19.8 0.5 Greater than nine to twelve months - - 16.4 1.2 16.4 1.2 Greater than twelve to twenty-four months - - 26.8 3.3 26.8 3.3 Greater than twenty-four to thirty-six months 18.0 3.3 11.6 6.8 29.6 10.1 Greater than thirty-six months 546.0 197.0 328.1 165.0 874.1 362.0 Total fixed maturities, available-for-sale$ 888.5 $ 206.8 $ 781.7 $ 187.3 $ 1,670.2 $ 394.1 December 31, 2012 Public Private Total Gross Gross Gross Carrying unrealized Carrying unrealized Carrying unrealized amount losses amount losses amount losses (in millions) Three months or less$ 32.9 $ 0.4$ 47.6 $ 0.8 $ 80.5 $ 1.2 Greater than three to six months 7.5 0.1 76.1 1.6 83.6 1.7 Greater than six to nine months 11.0 1.2 17.1 1.4 28.1 2.6 Greater than nine to twelve months - - 26.7 1.6 26.7 1.6 Greater than twelve to twenty-four months 17.7 5.1 33.5 2.8 51.2 7.9 Greater than twenty-four to thirty-six months 6.8 0.3 12.4 8.4 19.2 8.7 Greater than thirty-six months 556.2 251.7 400.4 208.7 956.6 460.4 Total fixed maturities, available-for-sale$ 632.1 $ 258.8 $ 613.8 $ 225.3 $ 1,245.9 $ 484.1 The following tables present the carrying amount and the gross unrealized losses, including other-than-temporary impairment losses reported in OCI, on fixed maturities available-for-sale where the estimated fair value had declined and remained below amortized cost by 20% or more as of the periods indicated. June 30, 2013 Problem, potential problem, All other fixed maturity and restructured securities Total Gross Gross Gross Carrying unrealized Carrying unrealized Carrying unrealized amount losses amount losses amount losses (in millions) Three months or less $ 20.1 $ 5.7$ 15.3 $ 4.3$ 35.4 $ 10.0 Greater than three to six months - - 20.8 13.7 20.8 13.7 Greater than six to nine months - 0.1 2.2 1.5 2.2 1.6 Greater than nine to twelve months - - 0.4 0.3 0.4 0.3 Greater than twelve months 153.3 233.2 368.1 216.9 521.4 450.1 Total fixed maturities, available-for-sale $ 173.4 $ 239.0$ 406.8 $ 236.7 $ 580.2 $ 475.7 121
-------------------------------------------------------------------------------- Table of Contents December 31, 2012 Problem, potential problem, All other fixed maturity and restructured securities Total Gross Gross Gross Carrying unrealized Carrying unrealized Carrying unrealized amount losses amount losses amount losses (in millions) Three months or less $ - $ - $ 7.7 $ 2.4$ 7.7 $ 2.4 Greater than three to six months - - 1.1 0.7 1.1 0.7 Greater than six to nine months - - 0.4 0.3 0.4 0.3 Greater than nine to twelve months 3.0 2.5 17.6 5.7 20.6 8.2 Greater than twelve months 194.1 269.0 457.0 379.5 651.1 648.5 Total fixed maturities, available-for-sale $ 197.1 $ 271.5$ 483.8 $ 388.6 $ 680.9 $ 660.1 Mortgage Loans Mortgage loans consist of commercial mortgage loans on real estate and residential mortgage loans. The carrying amount of our commercial mortgage loan portfolio was$10,849.0 million and$10,167.7 million as ofJune 30, 2013 andDecember 31, 2012 , respectively. The carrying amount of our residential mortgage loan portfolio was$587.8 million and$657.7 million as ofJune 30, 2013 andDecember 31, 2012 , respectively. Commercial Mortgage Loans. We generally report commercial mortgage loans on real estate at cost adjusted for amortization of premiums and accrual of discounts, computed using the interest method and net of valuation allowances.
Commercial mortgage loans play an important role in our investment strategy by:
† providing strong risk-adjusted relative value in comparison to other investment alternatives;
† enhancing total returns and † providing strategic portfolio diversification. As a result, we have focused on constructing a solid, high quality portfolio of mortgages. Our portfolio is generally comprised of mortgages originated with conservative loan-to-value ratios, high debt service coverages and general purpose property types with a strong credit tenancy. Our commercial mortgage loan portfolio consists primarily of non-recourse, fixed rate mortgages on fully or near fully leased properties. The mortgage portfolio is comprised primarily of well anchored retail properties, office properties, general-purpose industrial properties and apartments. Our commercial mortgage loan portfolio is diversified by geography and specific collateral property type. Commercial mortgage lending in the state ofCalifornia accounted for 21% and 20% of our commercial mortgage loan portfolio as ofJune 30, 2013 andDecember 31, 2012 , respectively. We are, therefore, exposed to potential losses resulting from the risk of catastrophes, such as earthquakes, that may affect the region. Like other lenders, we generally do not require earthquake insurance for properties on which we make commercial mortgage loans. With respect toCalifornia properties, however, we obtain an engineering report specific to each property. The report assesses the building's design specifications, whether it has been upgraded to meet seismic building codes and the maximum loss that is likely to result from a variety of different seismic events. We also obtain a report that assesses, by building and geographic fault lines, the amount of loss our commercial mortgage loan portfolio might suffer under a variety of seismic events. The typical borrower in our commercial loan portfolio is a single purpose entity or single asset entity. As ofJune 30, 2013 andDecember 31, 2012 , the total number of commercial mortgage loans outstanding was 994 and 977, of which 66% and 68% were for loans with principal balances less than$10 million , respectively. The average loan size of our commercial mortgage portfolio was$10.9 million and$10.4 million as ofJune 30, 2013 andDecember 31, 2012 , respectively. Commercial Mortgage Loan Credit Monitoring. For further details on monitoring and management of our commercial mortgage loan portfolio, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 4, Investments - Mortgage Loan Credit Monitoring." We categorize loans that are 60 days or more delinquent, loans in process of foreclosure and loans with borrowers or credit tenants in bankruptcy that are delinquent as "problem" loans. Valuation allowances or charge-offs have been recognized on most problem loans. We categorize loans that are delinquent less than 60 days where the default is expected to be cured and loans with borrowers or 122
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credit tenants in bankruptcy that are current as "potential problem" loans. The decision whether to classify a loan delinquent less than 60 days as a potential problem involves significant subjective judgments by management as to the likely future economic conditions and developments with respect to the borrower. We categorize loans for which the original note rate has been reduced below market and loans for which the principal has been reduced as "restructured" loans. We also consider loans that are refinanced more than one year beyond the original maturity or call date at below market rates as restructured. There has been a decrease in the total level of problem, potential problem and restructured commercial mortgages during the first half of 2013 primarily due to loan payoffs, foreclosures, and improvement in general market fundamentals such as increases in employment, falling vacancies and relatively little new construction. The following table presents the carrying amounts of problem, potential problem and restructured commercial mortgages relative to the carrying amount of all commercial mortgages for the periods indicated. June 30, 2013 December 31, 2012 ($ in millions) Total commercial mortgages$ 10,849.0 $ 10,167.7 Problem commercial mortgages $ 35.5 $ 40.1 Potential problem commercial mortgages 94.1
177.6
Restructured problem commercial mortgages 0.9 - Total problem, potential problem and restructured commercial mortgages $ 130.5 $
217.7
Total problem, potential problem and restructured commercial mortgages as a percent of total commercial mortgages 1.20 % 2.14 % Commercial Mortgage Loan Valuation Allowance. The valuation allowance for commercial mortgage loans includes loan specific reserves for loans that are deemed to be impaired as well as reserves for pools of loans with similar characteristics where a property risk or market specific risk has not been identified but for which we anticipate a loss may occur. For further details on the commercial mortgage valuation allowance, see Item 1. "Financial Statements, Notes to Unaudited Consolidated Financial Statements, Note 4, Investments - Mortgage Loan Valuation Allowance." The valuation allowance decreased$4.1 million for the six months endedJune 30, 2013 , and decreased$13.0 million for the year endedDecember 31, 2012 . The decrease in the level of valuation allowance during 2013 and 2012 was related to the same market factors as those causing the decrease in the level of problem, potential problem and restructured commercial mortgages for the six months endedJune 30, 2013 . The following table represents our commercial mortgage valuation allowance for the periods indicated. June 30, 2013 December 31, 2012 ($ in millions) Balance, beginning of period $ 51.8 $ 64.8 Provision 6.0 13.5 Charge-offs (10.7 ) (26.7 ) Recoveries 0.6 0.2 Balance, end of period $ 47.7 $ 51.8 Valuation allowance as % of carrying value before reserves 0.44 % 0.51 % Residential Mortgage Loans. The residential mortgage loan portfolio is composed of home equity mortgages with an amortized cost of$441.9 million and$495.7 million and first lien mortgages with an amortized cost of$192.1 million and$206.4 million as ofJune 30, 2013 andDecember 31, 2012 , respectively. The home equity loans are generally second lien mortgages made up of closed-end loans and lines of credit. Non-performing residential mortgage loans, which are defined as loans 90 days or greater delinquent plus non-accrual loans, totaled$30.5 million and$32.3 million as ofJune 30, 2013 andDecember 31, 2012 , respectively.
We establish the residential mortgage loan valuation allowance at levels considered adequate to absorb probable losses within the portfolio based on management's evaluation of the size and current risk characteristics of the portfolio. Such evaluation considers numerous factors, including, but not limited to net charge-off trends, loss forecasts, collateral values, geographic location, borrower credit scores, delinquency rates, industry condition and economic trends. The changes in the valuation allowance are reported in net realized capital gains (losses) on our consolidated statements of operations.
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Our residential mortgage loan portfolio, and in particular our home equity loan portfolio, experienced an increase in loss severity from sustained elevated levels of unemployment along with continued depressed collateral values beginning in 2010. While these factors continue to drive charge-offs, loss rates overall have stabilized and the portfolio balance continues to decline. The following table represents our residential mortgage valuation allowance for the periods indicated. June 30, 2013 December 31, 2012 ($ in millions) Balance, beginning of period $ 44.4 $ 36.0 Provision 11.4 39.9 Charge-offs (11.3 ) (35.1 ) Recoveries 1.7 3.6 Balance, end of period $ 46.2 $ 44.4 Valuation allowance as % of carrying value before reserves 7.3 % 6.3 % Real Estate Real estate consists primarily of commercial equity real estate. As ofJune 30, 2013 andDecember 31, 2012 , the carrying amount of our equity real estate investment was$1,258.5 million , or 2%, and$1,172.5 million , or 2%, of U.S. invested assets, respectively. Our commercial equity real estate is held in the form of wholly owned real estate, real estate acquired upon foreclosure of commercial mortgage loans and majority owned interests in real estate joint ventures. Equity real estate is categorized as either "real estate held for investment" or "real estate held for sale." Real estate held for investment totaled$1,131.2 million and$1,092.5 million as ofJune 30, 2013 andDecember 31, 2012 , respectively. The carrying value of real estate held for investment is generally adjusted for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Such impairment adjustments are recorded as net realized losses and, accordingly, are reflected in our consolidated results of operations. For the six months endedJune 30, 2013 and the year endedDecember 31, 2012 , there were no such impairment adjustments. The carrying amount of real estate held for sale was$127.3 million and$80.0 million as ofJune 30, 2013 andDecember 31, 2012 , respectively. There were no valuation allowances as ofJune 30, 2013 orDecember 31, 2012 . Once we identify a real estate property to be sold and commence a plan for marketing the property, we classify the property as held for sale. We establish a valuation allowance subject to periodic revisions, if necessary, to adjust the carrying value of the property to reflect the lower of its current carrying value or the fair value, less associated selling costs. We use research, both internal and external, to recommend appropriate product and geographic allocations and changes to the equity real estate portfolio. We monitor product, geographic and industry diversification separately and together to determine the most appropriate mix. Equity real estate is distributed across geographic regions of the country with 75% of the concentration in the South Atlantic, Pacific, and West South Central regions ofthe United States as ofJune 30, 2013 . By property type, there is a concentration in office and retail that represented approximately 63% of the equity real estate portfolio as ofJune 30, 2013 . Other Investments Our other investments totaled$1,553.1 million as ofJune 30, 2013 , compared to$1,847.4 million as ofDecember 31, 2012 . Derivative assets accounted for$691.5 million and$996.0 million in other investments as ofJune 30, 2013 andDecember 31, 2012 , respectively. The remaining invested assets include equity method investments, which include real estate properties owned jointly with venture partners and operated by the partners.
International Investment Operations
Of our invested assets,$6,063.1 million were held by ourPrincipal International segment as ofJune 30, 2013 . The assets are managed by either ourPrincipal Global Investors segment or by the localPrincipal International affiliate. Due to the regulatory constraints in each country, each company maintains its own investment policies. As shown in the following table, the major category of international invested assets as ofJune 30, 2013 andDecember 31, 2012 , was fixed maturities. The following table excludes invested assets of the separate accounts. 124 --------------------------------------------------------------------------------
Table of Contents June 30, 2013 December 31, 2012 Carrying amount % of total Carrying amount % of total ($ in millions) Fixed maturities: Public $ 3,417.1 56 % $ 3,698.7 62 % Private 1.5 - - - Equity securities 504.6 8 126.1 2 Mortgage loans: Commercial 22.0 - 15.6 - Residential 662.9 11 678.7 11 Real estate held for sale 3.7 - 7.0 - Real estate held for investment 2.6 - 0.8 - Policy loans 25.5 1 26.7 1 Other investments: Investment in equity method subsidiaries 667.7 11 718.0 12 Direct financing leases 699.3 12 655.1 11 Derivative assets and other short-term investments 56.2 1 70.6 1 Total invested assets 6,063.1 100 % 5,997.3 100 % Cash and cash equivalents 126.9 105.4 Total invested assets and cash $ 6,190.0 $ 6,102.7 Per Chilean regulation, in order to offer its pension products, Cuprum is required to hold a 1% investment ("encaje") in each of the five funds it manages for its clients. Cuprum's investment in the encaje is dictated by client activity and all investment performance from encaje is retained by Cuprum. We acquired $340.5 million of encaje assets in conjunction with our February 4, 2013 , acquisition of Cuprum. The encaje assets are classified as equity securities, trading within our consolidated statements of financial position, with all mark-to-market changes reflected in net investment income. Fixed Maturities Exposure Economic and fiscal conditions in select European countries, including Greece , Ireland , Italy , Portugal and Spain, continue to cause credit concerns particularly to financial institutions and banks with exposure to the European periphery region. Our exposure to the region within our International investment operations fixed maturities portfolio is manageable, representing 5.9% and 6.2% of our total International invested assets as of June 30, 2013 and December 31, 2012 , respectively. Portfolio holdings with exposure to this region consist of fixed maturities issued in the same countries as our International operations by local subsidiaries of the European parent. Nearly all of the exposure is to bonds issued in Chile . In addition, we did not hold any sovereign debt issuances of the selected countries and had not bought or sold credit protection on sovereign issuances as of June 30, 2013 and December 31, 2012 . Financial sector exposure is to local subsidiary banks, subject to local capital requirements and banking regulation. The current financial exposure carries an average AA- local rating from S&P and the average time to maturity is 17 years. Non-financial sector exposure consists primarily of infrastructure bonds, which are backed by the project itself, often with minimum revenue guarantees from the government. The current non-financial exposure carries an average AA local rating from S&P. The current Italian exposure has an average time to maturity of 14 years. In addition, the current Spanish exposure has an average time to maturity of 13 years. As of June 30, 2013 , our total portfolio exposure had an average price of 108 (carrying value/amortized cost).
The following table presents the carrying amount of our European periphery zone fixed maturities exposure for the periods indicated.
June 30, 2013 December 31, 2012 Select European Exposure Italy Spain Total Italy Spain Total (in millions) Non-Sovereign: Financial institutions $ -$ 227.7 $ 227.7 $ -$ 237.3 $ 237.3 Non-financial institutions 14.6 117.5 132.1 11.1 125.4 136.5 Total$ 14.6 $ 345.2 $ 359.8 $ 11.1 $ 362.7 $ 373.8 125
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For further details on our U.S. investment operations exposure to these European countries, see "U.S. Investment Operations - Fixed Maturities."
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